uclogo.gif Economics 20500. Decision Analysis and Probability Models.

[CLICK HERE FOR THIS WEEK'S ASSIGNMENT]

Autumn 2002: Tue, Thurs 9:00-10:20am in Harper 406.
Instructor: Roger Myerson (myerson @ uchicago.edu). Office hours: Wed mornings in SS 427.
Prerequisite: Econ 201 and Statistics 220 or some prior study of probability. Enrollment limited to 32.

Course description: This course is a basic introduction to mathematical models of optimal decision-making under uncertainty. Students learn to use Monte Carlo simulation and other techniques for sophisticated computational analysis in spreadsheets. Topics include fundamentals of probability modeling (discrete and continuous random variables, correlation, and conditional expectation), utility theory with constant risk tolerance, optimization of decision variables, competitive bidding, analysis of investment portfolios, risk sharing and moral-hazard incentive problems, asset pricing in financial markets, dynamic models of growth and arrivals.

Course requirements:
The course grade will be based on homework [10%], a take-home midterm exam [40%], and a final exam [50%].
Homework may be done in groups, but take-home exams must be done alone.
The final exam will be handed out on the morning of Wed Dec 11, and it will be due by 4pm on Thurs Dec 12.

Text and software:
All students will need to use MS Excel (v5 or higher), together with the Simtools and Formlist add-ins which have been developed for this course. Students should download Simtools.xla and Formlist.xla from http://home.uchicago.edu/~rmyerson/addins.htm.
The instructor's book on "Probability Models for Economic Decisions" (to be published by Duxbury Press next year) will be the main text for the course. Printed copies are available in SS 101, and electronic copies are available here in Adobe PDF format. See http://home.uchicago.edu/~rmyerson/prbook.htm.
Before the first class meeting: Read at least pages 1-8 in Chapter 1. If you have a computer with Excel then you should also download and install Simtools.xla and Formlist.xla on your computer, and make sure that you can open our first spreadsheet correctly. If you do not have a computer, then you should visit your computer lab and try working with our first spreadsheet there. (The USITE staff can help if the Simtools and Formlist addins have not yet been installed on machines in the computer lab where you want to work.)

Weekly topics:

  1. Read Chapter 1, except sections 1.6 and 1.7. [sales.xls] Homework due Oct 8: Ch 1 problems 1, 3, 7. [answer] (Hand in printout showing your model and analysis, with all formulas listed. Do not hand in pages of simulation data!)
  2. Read Chapter 2 [discrete.xls]. Homework due Oct 14: Ch 2 problems 1, 2, 4. [answer] (Please use File:PageSetup:Sheet to tell Excel to print the row and column headings!)
  3. Read Sections 3.1 and 3.2 in Chapter 3 [util.xls]. Homework due Oct 22: Ch 3 problems 1, 2, 3.  [answer]
  4. Read Chapter 4 (but section 4.8 can be just skimmed). [genldist.xls]
    For Tuesday Oct 29, do Ch 4 problems 1-3 (Lepton case) and 5 (Global Sports case).
    Then, for Thursday Oct 31, do Ch 4 problem 4 (subjective assessments) but 4(a) should be "the number on the last numbered page in Varian's Intermediate Microeconomics (before Appendix)". [answer]
  5. Read Chapter 5 [joint.xls]. The take-home midterm will be handed out Nov 5 and will be due by 4:00pm Nov 6.
  6. Read in Chapter 6 [conde.xls] at least sections 6.1, 6.2, 6.3, and 6.6. Homework due Nov 12: do problems 1, 2, and 4 in Chapter 5. [answer]
  7. Read in Chapter 7 [decvars.xls] at least sections 7.1 and 7.2. Homework due Nov 19: do problem 3 in Chapter 6, and do problems 1, 2, and 3 in Chapter 7. [answer]
  8. Read sections 7.4 to 7.7 in Chapter 7. Homework due Dec 3: do problems 4, 5, 6 in Chapter 7. [answer]
  9. Read sections 8.1 and 8.2 in Chapter 8. Homework due Dec 5: do problems 2, 3acd (skip part b) in Chapter 8, and do problem 9 in Chapter 7. [answer]
    The final exam will be available (from this web site and from SS room 427) at 10am on the morning of Wed Dec 11, and it will be due by 4pm on Thurs Dec 12.

Chapters of text and accompanying spreadsheets:

  1. Introduction to probability models and simulation in spreadsheets. [Chapter 1] [sales.xls] (Independence, conditional probabilities, basic techniques of simulation in spreadsheets.)
  2. Discrete random variables. [Chapter 2] [discrete.xls] (Expected value and standard deviation from probabilities, simulation from inverse cumulative, law of large numbers, 95% confidence interval for expected value from sample data, the expected value criterion for optimal decisions, cumulative risk profiles)
  3. Utility theory with constant risk tolerance.  [Chapter 3] [util.xls] (Utility functions, certainty equivalent, constant risk tolerance.)
  4. Continuous random variables. [Chapter 4] [genldist.xls] (Normal distribution, central limit theorem, Lognormal distribution for growth rates, the EXP and LN functions, fitting Generalized-lognormals for subjectively assessed quartiles.)
  5. Correlation and Multivariate Normal random variables. [Chapter 5] [joint.xls] (Covariance and correlation, using CORAND to simulate Multivariate Normals, linear combinations of random variables, portfolio analysis.)
  6. Conditional expectation. [Chapter 6] [conde.xls] (Expected posterior law, introduction to regression.)
  7. Optimization of decision variables. [Chapter 7] [decvars.xls] (Analysis of decision variables in simulation models, strategic value of information, use and limitations of Solver, newsboy problem, bidding problem, winner's curse.)
  8. Risk sharing and finance. [Chapter 8] [sharefin.xls] (Optimal risk sharing among investors with constant risk tolerances, moral-hazard incentive constraints, asset pricing with constant risk-tolerant investors.)
  9. Dynamic models of growth and arrivals. [Chapter 9] [dynamic.xls] (Net present value, forecasting models, Brownian motion, logoptimal investment strategies, exponential arrival and queuing models, project length models.)

Recommended supplementary texts:
"Decision Analysis," by H. Raiffa, McGraw-Hill, 1970.
"Risk Analysis: A Quantitative Guide" by D. Vose, 2nd ed., Wiley, 2000.
"Making Hard Decisions," by R. Clemen, 2nd ed., Duxbury, 1997.
"Insight.xla" by S. Savage, Brooks/Cole, 1998.
"Practical Management Science," W. Winston and C. Albright, 2nd ed., Duxbury, 2000.
"Spreadsheet Modeling and Decision Analysis" by C. Ragsdale, 3rd ed., South-Western, 2000.
"Introduction to Simulation and Risk Analysis" by J. Evans, D. Olson, Prentice-Hall, 1998.
"VBA for Modelers" by S. C. Albright, Duxbury, 2001.

URL of this course page:
http://home.uchicago.edu/~rmyerson/econ205.htm