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© 2014 Pacific Crest
129
M
ethodology
A
nalyzing
R
andomness
to
I
mprove
P
redictions and
D
ecision
M
aking
Scenario:
Buying trip cancellation insurance for a flight
Step
Explanation
Watch it Work!
1.
Clarify the
situation
Determine the actual
conditions that have to be
studied and understood
I am attending my sister’s wedding in 6 months.
I will be flying cross-country to the wedding
location. I have already purchased my airline
ticket.
2.
Define the action
to be taken
Determine the actual
decision/action that must
be made
Should I pay $25 for trip cancellation insurance
for my flight?
3.
Inventory the
important factors
What circumstances,
conditions, or
occurrences affect the
situation?
The travel insurance refunds the $600 I spent
on my ticket if I can’t travel due to some
circumstances: illness, missed trip/flight, or the
airline bankruptcy
4.
Identify factors
with large random
components
Which of the factors
identified are random?
illness (my or my family’s health), missed
trip (reasons such as death in the family or
cancellation of wedding), airline bankruptcy
5.
Rank the random
components
List the top 3 to 5 most
likely occurrences and
rank them from most to
least likely
●
illness (my or my family’s health)
●
death in the family
●
natural disaster/bad weather
●
cancellation of wedding
●
airline bankruptcy
6.
Clarify
implications of
each random
component
Determine the actual
probability or likelihood of
each random component
●
illness
: we’re all very healthy but accidents
can happen
●
death in the family
: no chronic conditions
but my parents are somewhat elderly
●
natural disaster/bad weather
: very unlikely
during autumn (the wedding date)
●
cancellation of wedding
: they’ve already
been happily together for 5 years
●
airline bankruptcy
: I’m using one of the
most financially healthy airlines
7.
Predict the
expected behavior
Determine which
outcome is the most
probable or likely
The chance of something happening that will
change my plans is very small
8.
Identify extreme
outcomes
Identify the worst possible
outcome
I don’t buy the insurance and have to cancel
my flight at the last minute. In that case it costs
me $200 for a change fee for the ticket.
9.
Make prediction or
decision
State the prediction or
decision arrived at on the
basis of the preceding
steps
The chance of something happening that will
change my plans is very small and the cost
of having to change the ticket (not having the
cancellation insurance) is not high.
I will NOT buy the insurance.
3.2 Finding Patterns in Random Behavior