Decision Trees in Financial Modeling
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Decision trees use diagrams to map the various investment decision alternatives and payoffs, along with their probabilities of occurrence.
Decision trees are named as such due to their resemblance to the branches of a tree, and rely on estimates of the probabilities associated with the outcomes (payoffs) of competing courses of action. The payoffs of each course of action are weighted by the associated probability; the weighted payoffs are summed; and the expected value of each course of action is then determined.
What Just Happened video Desert Hearts hd Clearly, the alternative on the decision tree that provides the highest expected value will be chosen as the preferred course of action in a financial modeling and analysis exercise.