What options are available to the decision maker if the prob

What options are available to the decision maker if the probabilities of the states of nature are unknown? Can you think of a way you might use sensitivity analysis in such a case?

Solution

Notice that both the payoffs and the probabilities in a decision problem are estimated values. Consequently, it can be useful for the decision maker to have some indication of how sensitive the choice of an alternative is to changes in one or more of these values. Unfortunately, it is impossible to consider all possible combinations of every variable in a typical problem. Nevertheless, there are certain things a decision maker can do to judge the sensitivity of probability estimates. Sensitivity analysis provides a range of probability over which the choice of alternatives would remain the same. The approach illustrated here is useful when there are two states of nature. It involves constructing a graph and then using algebra to determine a range of probabilities for which a given solution is best. In effect, the graph provides a visual indication of the range of probability over which the various alternatives are optimal, and the algebra provides exact values of the endpoints of the ranges.