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Acts of God and ManRuminations on Risk and Insurance$
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Michael Powers

Print publication date: 2014

Print ISBN-13: 9780231153676

Published to Columbia Scholarship Online: November 2015

DOI: 10.7312/columbia/9780231153676.001.0001

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It’s All in Your Head

It’s All in Your Head

Bayesian Decision Making

(p.67) 5 It’s All in Your Head
Acts of God and Man

Michael R. Powers

Columbia University Press

The Bayesian paradigm provides an elegant framework for resolving problems of uncertainty by permitting one to treat all unknown parameters as random variables and thus impose prior probability distributions over them. This chapter begins by showing how this approach allows one to make explicit statements about the probability distributions of future observations, and then argues in favor of a “fundamentalist” (or “literalist”) Bayesian approach to generating prior probability distributions. Next, it introduces the expected-utility principle in a Bayesian context and explains how it leads to a very natural system for making decisions in the presence of uncertainty. Finally, it shows how the Bayesian decision framework is sufficiently powerful to address problems of extreme (Knightian) uncertainty.

Keywords:   Bayesian paradigm, probability distributions, future observations, extreme uncertainty, Bayesian approach, expected-utility principle

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