Decision making under uncertainty: Bayesian inference

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Individuals make decisions using biased tools. Citing Kahneman and Tverski we can say that many decisions are based on beliefs concerning the likelihood of uncertain events such as the outcome of an election, [. . . ], the future value of the dollar. These beliefs are usually expressed in statements such as I think that . . . , chances are . . . , it is unlikely that . . . [1]. How do we make investment decisions? We know that investment managers are biased when making investment decisions basing their beliefs on subjective views regarding their investment markets. Before delving into finance again, let’s see how we can complement our set of tools with an objective tool that signi cantly lowers the degree of bias in our cognitive processes.

Let’s take for example a school of English for children that wants to synergistically combine its current business with English lessons for its students’ parents. Consider that the manager deems pro table giving lessons to parents if the proportion of parents willing to enroll in the new courses for adults is at least 30%.

[1] Amos Tverski and Daniel Kahneman, Judgement under uncertainty: Heuristics and Biases, 1974, Science.

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