Overview of Chapter 12

In this lecture, we will cover several aspects of the

value of information:
• Expected value of information
• Perfect Information
• Imperfect information
• Information and complex problems
• Information, sensitivity analysis, and structuring
• Information and nonmonetary objectives
• Information and experts

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 Value of Information
What is the value of information?
From the decision analytic perspective, information
has no value when it leads to an action we would
have taken without the information, and is valuable
when it leads to an action different from the one we
would have taken without the information.
Information’s impact on future action determines its
value. This is the expected value of information.

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 Value of Information: Some Basics
Perfect information: If an expert’s information is
always correct, then the information is perfect.

P(Outcome A Expert Says “Outcome A Occurs”) = 1

If the expert predicts Outcome A, then there is 100%

chance it will occur. But also, she must identify what will
not happen, and never to predict Outcome A when a
different outcome occurs afterwards. Now that’s perfect!

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 Value of Information: Some Basics

What is the value of information?

From the decision analytic perspective, information
has no value when it leads to an action we would
have taken without the information, and is valuable
when it leads to an action different from the one we
would have taken without the information.
Information’s impact on future action determines its
value. This is the expected value of information.

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 Expected Value of Perfect Information

Expected Value of Perfect Information (EVPI)

Remember that we are thinking about the value of
information in a strictly a priori sense. That is, the
investor has not yet consulted the clairvoyant expert;
rather, he is considering whether to consult the
clairvoyant in the first place.
What is it worth to have certainty compared to
uncertainty concerning the outcome?

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 Expected Value of Perfect Information
This decision-tree
representation
reinforces the
future or expected
aspect of EVPI
because we
actually include a
decision branch
that represents the
possibility of
consulting the
clairvoyant.

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 Expected Value of Perfect Information
From the decision-tree (prior slide) we can see that
without consulting the clairvoyant, the EMV is $580.
The EMV with consulting the clairvoyant is $1,000.
The EVPI is the difference, $420. Note that there is a
50% chance the clairvoyant will say that the market
will go up.

Would you be willing to pay $420 to the clairvoyant?

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 Expected Value of Imperfect Information

How should the investor use the economist’s

information?
Solve the problem using imperfect information just
as we solved it for perfect information
That is, find the difference in EMV’s for the
possibility of using and not using the forecasts
This can be done by applying Bayes’ theorem.

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 Expected Value of Imperfect Information
To apply Bayes’ theorem, as discussed in Chapter 7, we must
first “flip” the probabilities to solve the probability tree. This
can be thought of as reversing arrows in the influence
diagram.

After “flipping”
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 Value of Information in Complex Problems

Situation one: complex problems with continuous

probability distributions, unlike the discrete
distribution problems we’ve been using
• Conceptually the two situations are the same
• The problem is in calculating EMVs. Alternative ways to
do this:
• Construct a discrete distribution as an approximation
• Use a Monte Carlo simulation
• Use analytical results

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 Value of Information in Complex Problems

Situation two: complex problems with many

uncertain events and…
• Perfect information
• Include informational arcs in the influence diagram for a
subset of events
• Ensure that the event is not downstream in the diagram from
the decision node
• Imperfect information
• Include an imperfect-information node in the influence
diagram that provides information to the decision maker

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 Value of Information, Sensitivity Analysis, and Structuring

Why do value-of-information analysis?

• To examine situations in which information is available
• To show how decisions can be made systematically
regarding what source of information to select
• To estimate how much an expert’s information might be
worth
• To assist indirectly in the structuring of decisions and in
the entire decision analysis process of developing a
requisite decision model

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 Value of Information, Sensitivity Analysis, and Structuring

The role of information in building a decision

structure
1. Find those variables to which the decision is
sensitive
• Use a tornado diagram
• These variables require probabilistic modeling
• I.e., begin structuring the probabilistic model
2. Perform sensitivity analysis on the probabilities

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 Value of Information, Sensitivity Analysis, and Structuring

3. Calculate EVPI for each uncertain event – this will

indicate where to collect more information
• If EVPI is low for an event, then there is little sense in
spending a lot of effort in reducing the uncertainty by
collecting information.
• If EVPI is high for an event, then it may indeed be
worthwhile to put considerable effort into the collection
of information.

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 Value of Information and Nonmonetary Objectives

4. Use the information you decided to collect to:

• Reduce uncertainty
• Improve the decision maker’s calculations of EMV
5. Continue structuring the decision to develop a
requisite decision model
• I.e., a model that appropriately addresses all essential
elements of the decision problem

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 Value of Information and Nonmonetary Objectives

What is the value of information when some or all

of the objectives are nonmonetary?
Some nonmonetary objectives: specify trade-offs
between cost and nonmonetary objectives
• E.g., a trade-off of cost per dollar for an improvement in
a product and customer retention
• Information about customer retention can now be valued
into monetary units

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 Value of Information and Nonmonetary Objectives

All nonmonetary objectives: define the nonmonetary

objectives quantitatively, and use the units of
measure in your calculations where you would have
used monetary units of measure (dollars)
• E.g., time to complete an assignment
• Information about time is now valuable
In both scenarios, the value (cost) of information is
determined by difference between the expected value of
deciding with the information and the expected value of
deciding without the information.

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 Value of Information and Experts
When using multiple experts, the more interrelated,
and therefore redundant, the information is that they
provide, the less valuable it is.
• The challenge is to get experts who look at the same
problem from different perspectives.
“It can even be the case that a highly diverse set of less
knowledgeable (and less expensive) experts can be much
more valuable than the same number of experts who are
more knowledgeable (and cost more) but give redundant
information!”
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 Summary
In this chapter, you have learned about the value of
information. Specifically:
The difference between perfect and imperfect
information
Techniques for calculating the value of information
Use of information in complex decisions, in the
decision-analysis process, and when dealing with
nonmonetary objectives
How to evaluate and select experts
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 LAC LEMAN FESTIVAL DE LA MUSIQUE (Synopsis)

The organizers of a music festival may use video from the Friday
concert to create a DVD to sell to those who come to the Saturday
concert. Attendance on Saturday is uncertain, as is the percentage
of those who attend on Saturday that will buy the DVD.
Is this a good idea?
If so, how many DVDs should be burned early Saturday morning and
offered for sale at that evening’s performance?
By that time, Friday attendance is known, along with whether it rained
on Friday, and there is a forecast for whether it will rain on Saturday.
Historical information on these variables may help us to predict
Saturday attendance; along with the results of a marketing survey,
such analysis will help us make better purchasing decisions.

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 LAC LEMAN FESTIVAL DE LA MUSIQUE (Synopsis)

Written Submission
Part A: Provide a complete forecast for attendance at Saturday
night’s performance using case Exhibit 1 only. Note: a complete
forecast acknowledges the uncertainty with a probability
distribution.

Part B: If 4,500 DVDs are produced on Saturday for the concert

later Saturday evening, what is the risk profile of profit
(including all costs related to the DVD project)? Also, make a
recommendation for how many DVDs to order from the
production company. Provide a risk profile for the profit that will
result.

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 SPRIGG LANE (Synopsis)
Tom Dingledine, the president of a natural-resources exploration company, has
to decide
whether to invest in a new gas-well-drilling opportunity. He already has a
spreadsheet that projects the most likely scenario for the well and calculates
the net present value (NPV) and internal rate of return (IRR).
Dingledine, however, has discussed six uncertainties with another investor; he
now needs to incorporate them into the analysis.
He has prepared a spreadsheet for two downside scenarios: in the first, gas
cannot be produced after the well is drilled; in the second, gas can be
produced but all other uncertainties are at their one-percentile worst possible
values.
A potential investor, Henry Ostberg, wants to know what the chances are that
the gas well willresult in a loss of value.

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 SPRIGG LANE (Synopsis)

Written Submission
Based on the base-case scenario and the two alternative
downside possibilities, is this investment economically
attractive? Also, what benefit can Monte Carlo simulation add to
Dingledine’s understanding of the economic benefits of the
Bailey prospect?

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 APPSHOP, INC. (Synopsis)

A regional director of a consulting firm must decide how to compete for a

major consulting contract.
Appshop can take a level-payment contract, a lower-level payment with
a prospective bonus for high performance, or bid on an RFP where a
significant reward is given contingent on the client’s savings.

Written Submission
Appraise the risk of the alternatives, and recommend what Eric Clark
should choose. Suppose Clark’s specific secondary incentive is to keep
blended revenue per hour above 150. How does that affect your view of
the risk.

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 CALAMBRA OLIVE OIL (Synopsis)

Frank Lockfeld, president and founder of Calambra Olive Oil, is

discussing over dinner with friends the order-quantity decision he is
facing. Lockfeld’s newly launched venture—to bring high quality,
vintage-dated California olive oil to market—has been selling product for
only three months, and has sold only 24 cases to date. Nevertheless,
even though the first-year marketing experiment has barely begun,
Lockfeld must decide by month’s end how many gallons of oil to order
for the next (1994 vintage) year.

Written Submission
How many gallons should Lockfeld order? Then, how would you
describe the situation Lockfeld is facing? Can you graphically depict it?
How and why?
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 [Link] (Synopsis)

A potential investor in a new on-line sheet-music business is ready to

deny funding based on simple expected monetary value. Further
reflection identifies potential downstream options. Two options are
important in the case of partial, but incomplete, success: to abandon the
business idea and sell the technology, or to switch to new technology
and keep the Web site.

Written Submission
Provide a description of any other contingent opportunities (generic) that
would add value to this business? Should Bernard invest in the
business? Does Bernard have reasonable cutoff levels to trigger action
on each of the ideas in the initial discussion question? What kinds of
assessment tools would you use to support your answers?
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