Lecture11 ENGS41 Post

5/11/2015
Value and Utility Functions

 Probability Theory
 Value Functions
 Definition of a value function
 Eliciting value functions
 Utility Functions
 Definition of a utility function
 Eliciting utility functions
Introduction
• Probabilities in Decision Analysis
▫ Example: Influence diagram for basic risky decision
1
5/11/2015
Introduction
• Probabilities in Decision Analysis
▫ Example: Decision tree for basic risky decision
Basics of Probability Theory

• Probability is the most common and theoretically-
supported method for describing uncertainty
• Formulated by Kolmogorov’s axioms (1933):
▫ Event space 
▫ Probability function P: ()  [0,1] :

1. P(A) ≥ 0  A  
2. P() = 1
3. P(A  B) = P(A) + P(B) if A  B = 
2
5/11/2015

• Definitions
▫ Conditional probability:
P( A  B)
P( A B) 
P( B)
▫ Independence:
P ( A B)  P ( A)
 P ( A  B )  P( A) P ( B )

• Reversing conditional probabilities:
▫ Conditional probability:
P( A  B)
P( A B) 
P( B)
▫ Re-formulation:
P( A  B)  P ( A B ) P( B)  P( B A) P( A)
▫ Bayes’ Rule:
P( B A) P( A)
P( A B) 
P( B)
n
P ( B )   P ( B Ai ) P( Ai )
i 1
3
5/11/2015
Interpretations of Probability
▫ To apply the mathematical theory of probability to
aspects of the real world we need a “physical” or
“psychological” interpretation.
▫ At least two different interpretations have been
suggested (both of which adhere to Kolmogorov’s
axioms):
 Frequentist interpretation
 Personalist (subjective or
Bayesian) interpretation
• Frequentist Interpretation
▫ The probability of an event represents the long-run
frequency of similar events over repeated observations
▫ Useful for statistical inference about underlying
regularities in random systems based on repeated
measurements
▫ Strictly applies only to learning
from data
4
5/11/2015
• But what is the relevant population of similar events
for:
▫ Tomorrow’s weather?
▫ Next week’s playoff game?
▫ Next month’s court case?
▫ An earthquake at a nuclear
waste storage facility?
• Subjective Interpretation
▫ The probability of an event represents the “degree of
belief” that a person has that the event will occur, given
all relevant information currently known to that person.
▫ Explicitly a function of the state of information
▫ Frequencies may be one useful piece of information.
▫ Two or more people can rationally disagree.
▫ “Probability does not exist.” –Bruno de Finetti
5
5/11/2015
• Subjective Interpretation (cont’d)
▫ Still adheres to Kolmogorov’s axioms (must be
coherent)
▫ Bayes’ rule becomes a method for updating beliefs
after obtaining new data (information, evidence, etc.)
P (e A) P ( A)
P ( A e) 
P ( e)
Likelihood  Prior
Posterior 
Normalizing Constant
Example of Bayes’ Rule

• Your aging pet cat seems to not be feeling well. After
speaking with some friends you become concerned that she
may have chronic kidney disease. If so, then you would need
to begin to feed her a special diet.
• Based on the comments of your friends, you assess a 10%
probability that she has the disease, but would like to take her
to the vet for a test.
• The vet performs a blood test and tells you that it came back
positive.
• You ask the vet how accurate the test is and he tells you that
when a cat actually has the disease, a positive result will
occur 99% of the time, while if the cat does not have the
disease a false positive may occur 15% of the time.
• What is the probability that your cat has kidney disease?
10%? 99%? 15%? Or something else?
6
5/11/2015

What is the probability that your cat has kidney disease given the test
results?
D = has disease + = test positive
D’ = no disease - = test negative
P ( D) P ( D)
• We want P(D|+), which by Bayes’ rule is: P ( D  ) 
P(+|D) = 0.99 P ( )
P(D) = 0.10
n
P ( )   P ( Di ) P ( Di )
i 1
 P ( | D) P ( D)  P ( | D ' ) P ( D ' )
P(+|D’) = 0.15

What is the probability that your cat has kidney disease given
the test results?
P ( D) P( D)
P( D ) 
P ()
0.99  0.10

0.99  0.10  0.15  (1  0.10)
0.099

0.099  0.135
 0.423
7
5/11/2015
• Subjective Interpretation (cont’d)
▫ The subjective interpretation of probability includes
the frequentist interpretation as a limiting case,
because for random events it is reasonable to
believe that the chance for the next outcome is given
by the frequentist probability.
▫ On the other hand, the subjective interpretation has
a much wider field of application, as it can be used to
describe knowledge or belief about non-repeatable
and non-random events.
Eliciting Probabilities
• Elicitation of probabilities
▫ Subjective probabilities can be assessed by
elicitation.
▫ They can be made more tractable by comparison with
hypothetical bets on lotteries of outcomes.
▫ Formally describes existing knowledge
▫ Can be used to describe knowledge or belief about
non-repeatable and non-random events.
▫ Constitutes a “prior”, to be used either on its own or
updated using data through a Bayesian process.
8
5/11/2015
Fixed Probability Method

Reintroduced tiger will survive in the wild
Tiger survives $X
Lottery A
Tiger does not survive $0
25% $100
Lottery B
75% $0
Method
1. Set up Lottery B as a reference lottery with a well-specified
probability mechanism
2. Adjust the value of the winnings until the decision maker is
indifferent
p x X = 0.25 x 100 + .75 x 0
 p = 25/X
Fixed Probability Method

Tiger survives $X
Lottery A
25% $100
Lottery B
75% $0
Method (cont’d)
3. Use wide brackets and converge slowly
4. Check for consistency
9
5/11/2015
Fixed Value Method

Tiger survives $100
Lottery A
p $100
Lottery B
(1-p) $0
Method
1. Set up Lottery B as a reference lottery with a well-specified
probability mechanism
2. Adjust the probability of the reference lottery until the
decision maker is indifferent
3. Use wide brackets and converge slowly
4. Check for consistency
Fixed Value Method

Tiger survives $100
Lottery A
p $100
Lottery B
(1-p) $0
Problems
1. People may not like the idea of a game
2. People may have a hard time understanding the game
3. Problems such as anchoring may affect results
10
5/11/2015
• Find a partner such that at least one of you is actively

looking for a job or summer internship. This person will
be the ‘expert’ and the other person will be the ‘analyst’.
• The analyst should elicit from the expert the probability
that he/she will have found and committed to a job by
June 1, 2014.
Distributions
• Probability Density Function (PDF)
Probability distribution of X describes the probability
of possible results of X
  P ( xi ) if X is a discrete random variable

 xl  xi  xr
PX [ xl , xr ]   xr
  f ( x)dx if X is a continuous random variable
 xl
11
5/11/2015
Distributions
• Cumulative Distribution Function (CDF)
Distribution function: Probability for values less
than or equal to x:
  P( xi ) if X is a discrete random variable
 xi  x
FX  x    x
  f ( x' )dx' if X is a continuous random variable

How do we elicit subjective probabilities?
 Continuous quantities
1. Assess a number of cumulative probabilities to
derive a CDF
2. Assess “ends” and middle of distribution, then a
number of midpoints of segments
3. Calculate the derivative of the CDF to get the PDF
12
5/11/2015
Climate Sensitivity
• Climate sensitivity, S, is
defined as the equilibrium
global temperature
change in response to a
doubling in radiative
forcing.
• Climate sensitivity is a
variable about which
there is much uncertainty.
Continuous Quantities
1. Use reference lotteries to assess a number of
cumulative probabilities to derive a CDF
S < 2.0 deg C $100

Lottery A
S > 2.0 deg C $0
p $100
Lottery B
(1-p) $0
13
5/11/2015
2. Assess “ends” of distribution (0.10 and 0.90 fractiles)
and middle (median) by fixing p and assessing
corresponding S. Then assess a number of
midpoints of segments.
S < x deg C $100
Lottery A
S > x deg C $0
0.90 $100
Lottery B
0.10 $0
P < x degrees)
(Delta
P(S T < deg)
P(S < 1.25) = 0.10
1.00
P(S < 2.0) = 0.30
P(S < 2.25) = 0.5 0.75
Cum. Prob.
P(S < 2.30) = 0.70

0.50
P(S < 2.50) = 0.90
0.25
0.00
0.50
1.00
1.50
2.00
2.50
3.00
De gre e s
Can then take the derivative to get a probability

density function.
14
5/11/2015
Elicitation Exercise
Assess a continuous probability distribution for the amount of snow we will receive
in Hanover, NH, next winter (in whatever units you prefer). Do this with a partner
using the reference lottery approach. Use either the fixed probability or fixed
values approach (you and your partner might each try a different method). Draw
your CDF on graph paper. Using slopes, convert this to an approximate PDF.
Your challenge is for your distribution to be neither too narrow (i.e., overconfident)
nor too wide (underconfident).
30

 Value Functions
15
5/11/2015
31
Value Functions
• Preferences and Value Functions
 We want to analyse preferences of possible consequences
of management alternatives.
 The alternative leading to the most preferred consequences
is the one to be chosen.
To find the preferred alternative we need:
 an outcome model for decision alternatives, and
 a characterization of preferences over consequences.
 Preferences are defined for pairs of possible consequences.

means that the outcome y1 is preferred
y1  y2 to the outcome y .
2
32
Value Functions
Definition of a value function:
 An value function is a function which assigns each
outcome, y1, a real number v(y1), which is larger then v(y2)
if y1 is preferred to y2.
Note that in economics, value functions are often called “utility
functions.” In the decision sciences, the name utility function is
reserved for the description of preferences under uncertainty/risk.
16
5/11/2015
33
Value Functions
Existence of a value function:
For each preference that is
 transitive ( if y1  y 2 and y 2  y3 then y1  y3) and
 complete ( either y1  y2 or y2  y1 or y1  y2)

there exists an ordinal value function representing the
preference.
34
Value Functions
Non-uniqueness of value functions:
 Value functions are unique up to an
affine transformation (i.e., linear and
shift).
 Typically scaled to range from 0 to 1.
Interpretation of value functions:

 Existence as a mathematical
description of preferences, not as a
model of thinking of a human decision
maker (decision makers do not
explicitly maximise values).
 Construction of value functions by
analysis of preferences.
17
5/11/2015
35
Value Functions
 Human preferences are not always transitive and complete;
the assumptions can be questioned for a behavioural
decision theory. However, the assumptions seem
reasonable for a prescriptive theory.
 Completeness may limit the field of application of decision
theory (no alternatives with “extreme” outcomes).
36
Value Functions
• Elicitation of a Value Function
Single Attribute Case:
 Ask for preferences between exemplary outcomes, and
construct the value function by interpolation or smoothing.
 Do not ask for shape parameters of the value function directly
(value functions are mathematical representations of
preferences not “stored” in this form by the decision maker).
 Value functions are often normalised to the interval [0,1].
 After eliciting a value function, consistency checks have to be
performed.
18
5/11/2015
37
Value Functions
• Elicitation of a Measurable Value Function
 Direct Rating (not recommended)
Ordering of outcomes; specification of values compatible with
ordering and with preferences about switching between outcomes.
 Difference Standard Sequence Technique
Set value of worst outcome to zero; set value of outcome with
attribute value about 20% of span larger to unity; determine
subsequent outcome values so that value increments are unity;
normalise value function.
 Bisection Method (Midvalue Splitting Technique)
Determine worst and best outcome, set values to 0 and 1; identify
outcome with value of 0.5; identify outcomes with values of 0.25 and
0.75.
38
Value Functions
 Direct Rating – Continuous Case
ordering and with preferences about switching between outcomes
19
5/11/2015
39
Value Functions
 Direct Rating – Discrete Case
ordering and with preferences about switching between outcomes
For a job choice, the location

alternatives (from worst to best)
are:
40
Value Functions
 Difference Standard Sequence Technique
 Set value of worst outcome to zero; set value of outcome
with attribute value about 20% of span larger to unity;
determine subsequent outcome values so that value
increments are unity; normalise value function.
1
1.0
0.8 
1.0
0.6 
1.0
0.4 
1.0
0.2 
1.0
0
20
5/11/2015
41
Value Functions
Difference Standard Sequence Technique to assess
Value function for “time spent on a cruise ship”
1
0.857
0.714
0.571
0.429
0.286
0.143
0
42
Value Functions
 Bisection Method (Midvalue Splitting Technique)
 Determine worst and best outcome, set values to 0 and 1;
identify outcome with value of 0.5; identify outcomes with
values of 0.25 and 0.75.
21
5/11/2015
43
Value Functions
 Typical shape of a single attribute value function:
Decreasing marginal value:
Of special importance for attributes measured in monetary units
44
Value Functions
• Other Parametric Shapes
22
5/11/2015
45
Break and Practice Exercise

• Assess a continuous value function for the amount of
sleep you need per day.
• Do this with a partner using the Difference Standard
Sequence Technique or the Bisection Method.
46
Summary of Value Functions

• Decisions under Certainty with Value Functions
Assumptions:
▫ An outcome prediction model gives certain results for all
attributes for all decision alternatives.
▫ The value function is elicited from the decision maker as a
function of the attributes (preferences fulfil axioms).
 Values can be calculated for all decision alternatives.
 Decreasing values lead to a preference ranking of the
alternatives.
23
5/11/2015
47
Value Functions
 Utility functions should be considered when there is
uncertainty and a non-neutral attitude toward risk
Decisions nearly always have uncertainty, however value

functions can still be useful:
 Value functions are easier to elicit then utility functions;
 The application of value functions already leads to a clear
separation of predictions from valuations;
 Development of the theory for decisions under certainty is a
useful step towards the theory under uncertainty/risk;
 Uncertainty can still be (partially) taken into account through
sensitivity analysis.
48

 Value Functions
24
5/11/2015
49
Utility Functions
Most decisions are made under uncertainty,
therefore we need:
 a probabilistic outcome model (yielding a probability
of each possible outcome for each decision
alternative)
 appropriate characterization of preferences under
uncertainty (accounting for attitudes toward risk)
50
Utility Functions
Lotteries
p = 0.5 $1000
p = 0.5 - $1000
Would you pay to participate in this lottery?

If not, how much would you need to be paid?
25
5/11/2015
51
Utility Functions
• Preferences and Utility Functions
Definition of a utility function:
 A utility function describes preferences for both outcomes and
risk such that overall preference between actions with
uncertain outcomes is reflected by the expected values of the
utilities for each outcome.
 This is done by replacing outcomes in the value function
setting with lotteries of outcomes, designated Li
p y1
1–p y2
52
Utility Functions
• Axioms for Expected Utility:
1. Preferences among uncertain events called lotteries Li
can be specified based on consequences and
associated probabilities.
2. These preferences fulfill the following axioms:
1. Transitivity and completeness
If L1  L2 and L2  L3 then L1  L3
Also, either L1  L2 or L2  L1 or L1  L2
2. Continuity
If L1  L2  L3 then p : L2  p  L1  (1  p )  L3
3. Independence (substitutability)
If L1  L2 then p  L1  (1  p )  L3  p  L2  (1  p )  L3 L3
26
5/11/2015
53
Utility Functions
• Expected Utility Theory
If these assumptions hold, then…
1. It is possible to construct a utility function to represent your
preferences for uncertain outcomes, such that…
2. Your overall preference between lotteries of uncertain
outcomes is reflected by the expected utilities of each lottery
p1 U(y1) p2 U(y3)
1 – p1 U(y2) 1 – p2 U(y4)
54
Utility Functions
• Interpretation of Utility Functions
 Existence as a mathematical description of preference under
uncertainty, not as a model of thinking of a human decision
maker (decision makers do not explicitly maximize utility)
 Construction of utility functions by analysis of preferences
under uncertainty for an individual
 The shape of U(y) is a result of both the shape of the value
function and risk attitudes
27
5/11/2015
55
Utility Functions
• Typical risk averse utility function
Utility
0
Attribute
attribute range
56
Utility Functions
• Risk aversion as a positive risk premium
0.96
Expected
Utility 0.66
CE < E(X)  Risk Aversion

Risk
0.36 Premium
Outcome ($000)
Certainty Expected
Equivalent Outcome
28
5/11/2015
57
Utility Functions
• Other attitudes toward risk
Outcome
58
Utility Functions
• Non-uniqueness of utility functions
 Utility functions are only ordinal (they do not express strength

of preference)
 Utility functions are only unique up to an affine transformation
(linear and shift).
 Utilities are not absolute, but depend on the attribute ranges
29
5/11/2015
59
Utility Functions
• Elicitation of a Utility Function
Principles:
 Ask for preferences between reference lotteries and certain
outcomes
 Do not ask for shape parameters of the utility function directly
 Utility functions are usually normalised to the interval [0,1]
 After eliciting a utility function, consistency checks should be
performed
 It is often useful to compose a utility function as a function of
single attribute “sub-utility functions”
60
Utility Functions
 Certainty Equivalent Method
1. Assign outcomes of a 50/50 reference lottery to the best and worst
possible levels of the attribute; determine the attribute level for
which the decision maker would be indifferent between this level
with certainty and the reference lottery; this level is called the
“certainty equivalent” for the reference lottery and is assigned a
utility of 0.5.
2. Repeat by replacing the worst outcome with the outcome
determined in step 1 (with utility = 0.5); the resulting certainty
equivalent is assigned a utility of 0.75.
3. Repeat step 1 replacing the best outcome with the outcome with
utility = 0.5; the resulting certainty equivalent is assigned a utility of
0.25.
30
5/11/2015
61
Utility Functions
• Certainty equivalent method
p = 0.5 $100
Lottery A
p = 0.5 $ 10
Certainty B
CE
U(CE) = 0.5 U(100) + 0.5 U(10)

= 0.5 (1) + 0.5 (0)
= 0.5
62
Utility Functions
p = 0.5 $100
Lottery A
p = 0.5 CE’
Certainty B
CE
U(CE) = 0.5 U(100) + 0.5 U(CE’)

= 0.5 (1) + 0.5 (0.5)
= 0.75
31
5/11/2015
63
Utility Functions
Utility
0.75
0.5
0.25
0
Attribute
attribute range
64
Utility Functions
 Probability Method
1. Assign probabilities of a reference lottery values of p and 1-p for
the outcomes with the best and worst possible levels of the
attribute respectively; set the certainty equivalent to an
intermediate value; determine the value of p for which the decision
maker would be indifferent between the certainty equivalent and
the reference lottery; the value of p is equal to the utility of the
certainty equivalent.
2. Repeat with other intermediate values for the certainty equivalent.
32
5/11/2015
65
Utility Functions
• Probability method
p $100
Lottery A
1-p $10
Certainty B
$65
U(65) = p U(100) + (1-p) U(10)

= p (1) + (1-p) (0)
=p
66
Utility Functions
• Probability method
Utility
1
0.8
0.6
0.4
0.2
0
Attribute
attribute range
33
5/11/2015
67
Utility Functions
Utility
• Functional Forms
1
U(x) = log(x)
U(x) = 1-exp(-x/R)
U(x) = sqrt(x)
0  Each of which would

Attribute
attribute range then need to be
normalized to a [0,1]
utility range by
application of a linear
transformation.
68
Discrete Attributes
• Utility Function Assessment
▫ Generalized procedure
34
5/11/2015
69
Discrete Attributes
• Utility Function Assessment
▫ Probability method
p San Francisco
Lottery A
1-p Ann Arbor
Certainty B Boston
U(BO) = p U(SF) + (1-p) U(AA)

= p (1) + (1-p) (0)
=p
70
Practice Exercise
• With a partner, assess each other’s utility function for

money over the range $0 to $1000 using the Certainty
Equivalent Method or Probability Method.
35

Lecture11 ENGS41 Post

Caricato da

Informazioni sul documento

Copyright

Formati disponibili

Condividi questo documento

Condividi o incorpora il documento

Opzioni di condivisione

Hai trovato utile questo documento?

Questo contenuto è inappropriato?

Copyright:

Formati disponibili

Lecture11 ENGS41 Post

Caricato da

Copyright:

Formati disponibili

5/11/2015

Value and Utility Functions

Basics of Probability Theory

▫ Event space 

▫ Probability function P: ()  [0,1] :

3. P(A  B) = P(A) + P(B) if A  B = 

Basics of Probability Theory

Basics of Probability Theory

Example of Bayes’ Rule

Example of Bayes’ Rule

Example of Bayes’ Rule

Fixed Probability Method

Tiger does not survive $0

Fixed Probability Method

Tiger does not survive $0

Fixed Value Method

Tiger does not survive $0

Fixed Value Method

Tiger does not survive $0

• Find a partner such that at least one of you is actively

  P ( xi ) if X is a discrete random variable

S < 2.0 deg C $100

S > 2.0 deg C $0

P(S < 2.30) = 0.70

Can then take the derivative to get a probability

Value and Utility Functions

 a characterization of preferences over consequences.

 Preferences are defined for pairs of possible consequences.

 complete ( either y1  y2 or y2  y1 or y1  y2)

Interpretation of value functions:

For a job choice, the location

Decreasing marginal value:

Of special importance for attributes measured in monetary units

Break and Practice Exercise

Summary of Value Functions

Decisions nearly always have uncertainty, however value

Value and Utility Functions

Would you pay to participate in this lottery?

CE < E(X)  Risk Aversion

 Utility functions are only ordinal (they do not express strength

U(CE) = 0.5 U(100) + 0.5 U(10)

U(CE) = 0.5 U(100) + 0.5 U(CE’)

U(65) = p U(100) + (1-p) U(10)

0  Each of which would

1-p Ann Arbor

U(BO) = p U(SF) + (1-p) U(AA)

• With a partner, assess each other’s utility function for

Potrebbero piacerti anche