Handbook of Decision Analysis

CHAPTER ELEVEN

Perform Probabilistic Analysis and Identify Insights

ERIC R. JOHNSON and STEVEN N. TANI

An organization’s ability to learn, and translate that learning into action rapidly, is the ultimate competitive advantage.

—Jack Welch

11.1 Introduction

11.2 Exploration of Uncertainty: Decision Trees and Simulation

11.2.1 Decision Trees

11.2.2 Simulation

11.2.3 Choosing between Monte Carlo Simulation and Decision Trees

11.2.4 Software for Simulation and Decision Trees

11.3 The Value Dialogue

11.3.1 P&L Browsers

11.3.2 Total Value and Value Components

11.3.3 Cash Flow over Time

11.3.4 Direct EV Tornado Diagram

11.3.5 Delta EV Tornado Diagram

11.3.6 One-Way and Two-Way Sensitivity Analysis

11.3.7 Value of Information and Value of Control

11.3.8 Real Options

11.3.9 S-Curves (Cumulative Probability Distributions)

11.3.10 Flying Bar Charts

11.4 Risk Attitude

11.4.1 Delta Property

11.4.2 Exponential Utility

11.4.3 Assessing Risk Tolerance

11.4.4 Calculating Certain Equivalents

11.4.5 Evaluating “Small” Risks

11.4.6 Going Beyond the Delta Property

11.5 Illustrative Examples

11.5.1 Geneptin Example

11.5.2 Data Center

11.6 Summary

Key Terms

References

11.1 Introduction

Previous chapters discuss initial development of a composite perspective on what drives value for the decision. To improve and exploit the composite perspective, we must find ways to understand the behavior of value that emerges from this model and test these against individuals’ perspectives. For decisions involving significant ...