INTRODUCTION TO DECISION ANALYSIS (Economics ) Prof. Klaus Nehring Spring Syllabus

Transcription

1 INTRODUCTION TO DECISION ANALYSIS (Economics ) Prof. Klaus Nehring Spring 2003 Syllabus Office: 1110 SSHB, Office Hours (tentative): T 10:00-12:00, W 4:10-5:10. Prerequisites: Math 16A, Statistics 13, Econ 100. Required Reading: Howard Raiffa, Decision Analysis: Introductory Lectures on Choices under Uncertainty. Addison-Wesley 1968, chapters 1-5. (The book costs new $50.00 which is ridiculous; the relevant chapters will be made available at an affordable cost). Reader Introduction to Decision Analysis will be available at Navin s. Optional Further Reading: The following are two superb books on applying decision analysis written for the general reader. The first emphasizes everyday applications, the second business applications. Hammond, J., Kenny, R., and H. Raiffa (1999): Smart Choices, Harvard Business School Press. Russo, J. and P. Shoemaker (2002): Winning Decisions, Doubleday. 1

2 Program: The course has two main themes. First, how to think about and make good decisions; this is normative decision analysis. And second, how people in fact tend to make decisions; this is descriptive decision analysis. Descriptive decision analysis demonstrates the existence of many hidden traps in people s decision making. Normative decision analysis provides the conceptual tools to analyze decision problems effectively and overcome those traps; it will help you make smarter choices, both in your private and your professional life. You will also better understand economic risk and uncertainty, for instance in the context of financial markets. Course Requirements and Organization: There will be regular, almost weekly, homework assignments. Regular work on the homework is absolutely necessary to succeed in the class. To further encourage it, I will include in each exam at least one problem from a prior homework. While the textbook material is fairly small (a bit more than 100 pages), there will be a large amount of additional required reading introducing to the great variety of real-world applications. Grading: Midterm (+possibly quizzes) 50% + Final 50%. reader. I may adjust the grade one step up for regular, intelligent participation. I may change the grading scheme somewhat depending on the availability of a 2

3 1. INTRODUCTION Hammond, J. et al. (1998), The Ten Hidden Traps in Decision Making, Harvard Business Review Tversky, A. and D. Kahneman (1986): Rational Choice and the Framing of Decisions, Journal of Business 59, THE BASICS OF PROBABILITY The Basic Principles of Probability, from: R. Dawes (1988), Rational Choice in an Uncertain World, Harcourt Brace Jovanovich, Revising Beliefs with New Information: Bayes Rule Thaler, R. (1988): The Winner s Curse, Journal of Economic Perspectives 2, HEURISTICS AND BIASES Tversky, A. and D. Kahneman: Judgement under Uncertainty: Heuristics and Biases, in KST, Tversky, A. and D. Kahneman (1983): Extensional versus Intuitive Reasoning, Psychological Review 90, Saks, M. and R. Kidd (1980): Human Information Processing and Adjucation; Trial by Heuristics, Law and Society Review 15, VISUALIZING LINKED DECISIONS: DECISION TREES RAIFFA, ch. 1 & 2 3

4 Picture Risk Profiles with Decision Trees, Linked Decisions, from: Hammond, J., Kenny, R., and H. Raiffa: Smart Choices, Harvard Business School Press 1999, , Application to Finance: Option Pricing Options and Corporate Finance: Basic Concepts, ch. 22 of Ross, Westerfield, and Jaffe (2002), Corporate Finance, Irwin. 5. DECISION MAKING UNDER RISK The Economic Approach: Expected Utility Theory RAIFFA, ch. 4 Jeffrey, R. (1988): Biting the Bayesian Bullet: Zeckhauser s Problem, Theory and Decision 25, The Psychological Approach: Prospect Theory Kahneman, D. and A. Tversky (1979): Prospect Theory: An Analysis of Decision under Risk, Econometrica 47, Thaler, R. (1985): Mental Accounting and Consumer Choice, Marketing Science 4, Kahneman, D. et al. (1990): Experimental Tests of the Endowment Effect and the Coase Theorem, Journal of Political Economy 98, Benartzi, S. and R. Thaler (1995): Myopic Loss Aversion and the Equity Premium Puzzle, Quarterly Journal of Economics 110,

5 6. REAL UNCERTAINTY Assessing Chances: Subjective Probability RAIFFA, ch.5 Ellsberg, D. (1961): Risk, Ambiguity and the Savage Axioms, QJE 75, Intelligence in the Face of Uncertainty, in Russo, J. and P. Shoemaker (2002), Winning Decisions, Doubleday, Predictive Accuracy of Individuals Yates, F., Judgment and Decision Making, Englewood Cliffs 1990, ch. 3 and 4 Oskamp, S., Overconfidence in Case-Study Judgments, in: KST, Morgan and Henrion, Uncertainty, Cambridge UP, Are Experts Different?, Choosing: A Pyramid of Approaches, in Russo, J. and P. Shoemaker (2002), Winning Decisions, Doubleday, Predictive Accuracy of Financial Markets Haugen, R. (1997): Market Efficiency in: Modern Investment Theory, Prentice Hall, , , Thaler, R. and W. Ziemba (1988), Parimutuel Betting Markets: Racetracks and Lotteries, Journal of Economic Perspectives 4, De Bondt, W. and R. Thaler (1990): Do Security Analysts Overreact?, American Economic Review 80, Barber, B. and T. Odean (2001), Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment, Quarterly Journal of Economics 116,