Mutual Funds of the Northeast has to make a decision to invest in one of four al

Question

Mutual Funds of the Northeast has to make a decision to invest in one of four alternatives in the stock market: a blue chip stock offering, a growth stock offering, a new ventures stock offering, and treasury bills. The investment environment can assume any one of four states, and Mutual has no prior information about what the market will do. Mutual's payoff table looks like this: Using the minimax regret criterion for decision making, evaluate each type of investment, and determine which is preferable.

Explanation / Answer

In the minimax regret approach, we choose the alternative with a minimum of all maximum regrets across all alternatives.

Regrets = opportunity cost or Best payoff - payoff received

In the boom,Best payoff = 500,000

Therefore, regret Table is:

Now we determine the maximum regret of each alternative and then choose the minimum,

Therefore, The decision is to invest in Treasury Bills.

Regrets Blue chip Growing Venture TB Boom 250000 125000 0 20000 Moderate growth 75000 0 50000 120000 Moderate decline 30000 80000 180000 0 collapse 330000 430000 530000 0

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