MONTE CARLO SIMULATION OF UTILITY FUNCTION SHAPES

Utility is one of the basic components of decision-making. While used to make decisions under risk, it is also an approach of multi-criteria decision-making. The principles of the utility theory are used for value functions. The utility function can adopt three basic shapes: linear, concave and convex. Each shape describes a different approach of the decision maker towards the risk. For maximizing criteria as profit, the concave shape represents a risk averse attitude of the decision maker, whereas, the convex represents risk-prone decision maker. At the end of the decision-making process, the decision is made based on the utility. The paper compares the three basic shapes of utility and their influence on decisions using the Monte Carlo simulation. Different ways to compute the utility are discussed and compared. Computation of the utility is an alternative approach to the commonly used subjective elicitation of the utilities. Advantages, disadvantages and usefulness of the approaches are discussed.