On the Relation between Robust and Bayesian Decision Making



Define the following sequence of transforming functions Tk():3

Tk (Z) = ekL

Since Tk() is increasingly convex as k increases, a Bayesian with objective
T
k (Z) will become increasingly risk averse in terms of the coefficient of absolute
risk aversion. As a result, the value of the transformed loss T
k(Z) increases
disproportionately with the size of the loss Z.

Intuitively, this implies that the largest of all losses Z associated with some
action
x obtains increasing relative weight. This should move the solution to the
Bayesian decision problem closer and closer to the robust solution. Proposition
1 below con
firms this intuition:

Proposition 1 Let xk denote the solution to the transformed Bayesian decision
problem (6) with prior probabilities
pi > 0 (i = l,...n). Let xtr denote the
solution to the robust decision problem (f). Then

Iim ∣∣χk - <11 = 0
k→∞

The proof of proposition 1 can be found in the appendix. Proposition 1
shows that robust decisions can be interpreted as decisions of a Bayesian with
an in
finite degree of risk-aversion and arbitrary strictly positive priors over the
domain to which the robust decision maker cannot assign prior probabilities.
In Bayesian terms the desire for robustness represents a choice of a particular
objective function, which has the property that optimal decisions are robust to
the assignment of prior probabilities.

The next subsection illustrates proposition 1 using a univariate example.

3.1 An Example

Consider the following simple loss function, which has been considered amongst
others by Brainard (1967) and Onatski (2000):

Z(x, s) = (sx π*)2

The variable π* denotes an inflation target pursued by the central bank while
sx denotes the in
flation rate that results when the decision maker chooses policy
3The particular sequence Tk is just chosen for convenience and other sequences might give
the same result.



More intriguing information

1. Secondary school teachers’ attitudes towards and beliefs about ability grouping
2. Sustainability of economic development and governance patterns in water management - an overview on the reorganisation of public utilities in Campania, Italy, under EU Framework Directive in the field of water policy (2000/60/CE)
3. Discourse Patterns in First Language Use at Hcme and Second Language Learning at School: an Ethnographic Approach
4. Structure and objectives of Austria's foreign direct investment in the four adjacent Central and Eastern European countries Hungary, the Czech Republic, Slovenia and Slovakia
5. Update to a program for saving a model fit as a dataset
6. MANAGEMENT PRACTICES ON VIRGINIA DAIRY FARMS
7. Experimental Evidence of Risk Aversion in Consumer Markets: The Case of Beef Tenderness
8. The problem of anglophone squint
9. Experience, Innovation and Productivity - Empirical Evidence from Italy's Slowdown
10. From music student to professional: the process of transition