Decision Theory

DEFINITION of 'Decision Theory '

An interdisciplinary approach to determine how decisions are made given unknown variables and an uncertain decision environment framework. Decision theory bring together psychology, statistics, philosophy and mathematics to analyze the decision-making process. Decision theory is applied to a wide variety of areas such as game theory, auctions, evolution and marketing.

BREAKING DOWN 'Decision Theory '

A common example of decision theory stems from the prisoner's dilemma in which two individuals are faced with an uncertain decision where the final outcome is not only based on their personal decision, but also on that of the other individual. Since both parties do not know what actions the other person will take, this results in an uncertain decision framework.
While mathematics and statistical models determine what the optimal decision should be, psychology and philosophy introduce factors of human behaviors to suggest the most likely outcome.

RELATED TERMS
  1. Financial Economics

    A branch of economics that analyzes the use and distribution ...
  2. Revealed Preference

    An economic theory of consumption behavior which asserts that ...
  3. Modern Portfolio Theory - MPT

    A theory on how risk-averse investors can construct portfolios ...
  4. Accelerator Theory

    An economic theory that suggests that as demand or income increases ...
  5. Search Theory

    A study of buyers and sellers who cannot instantly find a commerce ...
  6. Chaos Theory

    A mathematical concept that explains that it is possible to get ...
Related Articles
  1. Options & Futures

    Using Decision Trees In Finance

    These decision-making tools play an integral role in corporate finance and economic forecasting.
  2. Investing

    Asset Manager Ethics: Acting With Competence and Diligence

    Managers must make investment decisions based on their personal investment process, which in turn should be based on solid research and due diligence.
  3. Economics

    Prisoner's Dilemma

    Learn more about this classic game theory scenario.
  4. Investing Basics

    Is There An Investing State Of Mind?

    The right investment philosophy can help traders remain profitable during these troubled economic times.
  5. Trading Strategies

    Does Your Personality Match Your Trading Methods?

    Investing has ways to successfully accommodate a variety of personalities. Learn how to align your trading with your traits.
  6. Active Trading Fundamentals

    Dow Theory: Current Relevance

    By Chad Langager and Casey Murphy, senior analyst of ChartAdvisor.comThere is little doubt that Dow theory is of major importance in the history of technical analysis. Many of its tenets and ...
  7. Economics

    5 Nobel Prize-Winning Economic Theories You Should Know About

    Here are 5 prize-winning economic theories that you’ll want to be familiar with.
  8. Active Trading Fundamentals

    Behavioral Finance: Introduction

    By Albert PhungAccording to conventional financial theory, the world and its participants are, for the most part, rational "wealth maximizers". However, there are many instances where emotion ...
  9. Personal Finance

    Microeconomics: A Brief History

    by Marc DavisAs early as the 18th century, economists were studying the decision-making processes of consumers, a principal concern of microeconomics. Swiss mathematician Nicholas Bernoulli (1695-1726) ...
  10. Term

    Interest Rate Predictions With Expectations Theory

    The expectations theory uses long-term interest rates to predict future short-term interest rates.
RELATED FAQS
  1. Why is Game Theory useful in business?

    Game theory was once hailed as a revolutionary interdisciplinary phenomenon bringing together psychology, mathematics, philosophy ... Read Answer >>
  2. How are business decisions made in a partnership?

    Understand how partners in a business can tackle decision making, and learn the options available for partnerships to develop ... Read Answer >>
  3. Is a good's production cost related to its value?

    Learn about the history and debate regarding the metrics used to determine the value of a good and which theories place emphasis ... Read Answer >>
  4. What is the difference between capital investment decision and current asset decision?

    Learn how capital investment decisions are long-term funding decisions, while current asset decisions are short-term funding ... Read Answer >>
  5. How is the Dow Jones Industrial Average used in the Dow theory?

    Discover how the Dow Jones Industrial Average is used in the Dow Theory, which is used by traders to figure out the trend ... Read Answer >>
  6. What are common examples of bad decisions made due to the sunk cost fallacy?

    Learn more about the ways some businesses reject proper analysis in favor of the sunk cost fallacy, and discover ways to ... Read Answer >>
Hot Definitions
  1. Demand Curve

    The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity ...
  2. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  3. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  4. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  5. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  6. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
Trading Center