Question: A decision maker is working on a problem that requires her to study the uncertainty surrounding the payoff of an investment. There are three possible
| A decision maker is working on a problem that requires her to study the uncertainty surrounding the payoff of an investment. | |||||||||||
| There are three possible levels of payoff -$1,000, $5,000, and $10,000. As a rough approximation, the decision maker believes that each possible payoff is equally likely. | |||||||||||
| But she is not fully comfortable with the assessment that each probability is exactly 1/3, and so would like to conduct a sensitivity analysis. | |||||||||||
| In fact, she believes that each probability could range from 0 to 1/2. | |||||||||||
| A. | Show how a Monte Carlo simulation could facilitate a sensitivity analysis of the probabilities of the payoffs. | ||||||||||
| B. | Suppose the decision maker is willing to say that each of the three probabilities could be chosen from a uniform distribution between 0 and 1. | ||||||||||
| Could you incorporate this information into your simulation? If so, how? If not, explain why not, or what additional information you would need. |
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