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A simple model of decision making: How to avoid large outliers?

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  • Varsanyi, Zoltan

Abstract

In this paper I present a simple model through which I examine how large unwanted outcomes in a process subject to one’s decisions can be avoided. The paper has implications for decision makers in the field of economics, financial markets and also everyday life. Probably the most interesting conclusion is that, in certain problems, in order to avoid large unwanted outcomes one, regularly and intentionally, has to make decisions that are not optimal according to his/her existing preference. The reason for it is that the decision rule might get “overfitted” to one’s (recent) experience and may give wrong signals if there is a change, even as temporary as in one single period, in the environment in which decisions are made. I find the optimal decision making strategy in an example case – the optimal strategy, however, may well be different in different real-world situations.

Suggested Citation

  • Varsanyi, Zoltan, 2008. "A simple model of decision making: How to avoid large outliers?," MPRA Paper 9528, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:9528
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    File URL: https://mpra.ub.uni-muenchen.de/11070/1/MPRA_paper_11070.pdf
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    References listed on IDEAS

    as
    1. D. Sornette, 2003. "Critical Market Crashes," Papers cond-mat/0301543, arXiv.org.
    2. Riccardo Rebonato, 2007. "Introduction to Plight of the Fortune Tellers: Why We Need to Manage Financial Risk Differently," Introductory Chapters, in: Plight of the Fortune Tellers: Why We Need to Manage Financial Risk Differently, Princeton University Press.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    endogeneity; non-stacionarity; outliers; simulation; uncertainty;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General

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