Warren Buffy is an enormously wealthy investor who has built his fortune through
ID: 3042451 • Letter: W
Question
Warren Buffy is an enormously wealthy investor who has built his fortune through his legendary investing acumen. He currently has been offered three major investments and he would like to choose one. The first one is a conservative investment that would perform very well in an improving economy and only suffer a small loss in a worsening economy. The second is a speculative investment that would perform extremely well in an improving economy but would do very badly in a worsening economy. The third is a counter-cyclical investment that would lose some money in an improving economy but would perform well in a worsening economy. Warren believes that there are three possible scenarios over the lives of these potential investments: (1) an improving economy, (2) a stable economy, and (3) a worsening econ omy. He is pessimistic about where the economy is headed, and so has assigned proba- bilities of 0.6, 0.2, and 0.2, respectively, to these three scenarios. He also estimates that his profits (in millions of dollars) under these respective scenarios are those given by the following table:Explanation / Answer
a) maximin
In decision theory, the pessimistic (conservative) decision making rule under conditions of uncertainty. It states that the decision maker should select the course of action whose worst (maximum) loss is better than the least (minimum) loss of all other courses of action possible in given circumstances.
maximum of minimum
conservative = 0
speculative= -30
counter-cyclical = -5
since 0 is maximum
conservative
b)conservative = 0.6 * 30 + 0.2 * 5 = 19
speculative= 30*0.6 + 15 *0.2 -15*0.2 = 18
counter-cyclical = 25*0.6 + 10*0.2-5*0.2 = 16
19 is maximum
hence conservative
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