Decision Tree - General

General

In decision analysis, a "decision tree" — and the closely related influence diagram — is used as a visual and analytical decision support tool, where the expected values (or expected utility) of competing alternatives are calculated.

A decision tree consists of 3 types of nodes:-

1. Decision nodes - commonly represented by squares
2. Chance nodes - represented by circles
3. End nodes - represented by triangles

Drawn from left to right, a decision tree has only burst nodes (splitting paths) but no sink nodes (converging paths). Therefore, used manually, they can grow very big and are then often hard to draw fully by hand. Traditionally, decision trees have been created manually - as the aside example shows - although increasingly, specialized software is employed.

Commonly a decision tree is drawn using flow chart symbols as it is easier for many to read and understand.

Analysis can take into account the decision maker's (e.g., the company's) preference or utility function, for example:

The basic interpretation in this situation is that the company prefers B's risk and payoffs under realistic risk preference coefficients (greater than $400K—in that range of risk aversion, the company would need to model a third strategy, "Neither A nor B").