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Decisions with Estimation Uncertainty
Roger W. Klein
Lawrence C. Rafsky
David S. Sibley
Robert D. Willig
Abstract
This paper provides necessary and sufficient conditions for it to be optimal to base decisions on estimates of the parameters that characterize a decision problem (e.g., profit maximization with an estimated price elasticity of demand). We show that the separation of parameter estimation from decision making generally yields lower utility than an integrated approach which takes account of estimation uncertainty. We evaluate the decision bias in the parameter estimation method and show that the resulting utility loss can be substantial.
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