What does "expected value" rely on in decision-making?

The concept of "expected value" is a fundamental principle in decision-making, especially in the fields of economics and finance. It represents a way to account for the various potential outcomes of a decision, weighted by their probabilities. By calculating the expected value, decision-makers can evaluate mixed strategies, where multiple possible payoffs are considered, each with an associated likelihood of occurrence.

In this context, the expected value is determined by taking the payoffs from all possible outcomes, multiplying each payoff by the probability of its occurrence, and then summing these products. This method provides a comprehensive view of the potential results, allowing individuals and organizations to make informed decisions that reflect the average or expected outcome, rather than relying on extreme possibilities or simple averages.

The other options present different concepts related to decision-making but do not align with the definition of expected value. For example, focusing on maximum potential returns or the least favorable outcomes does not account for the probabilities of each outcome, which is crucial for calculating expected value. Similarly, using historical data exclusively for risk assessment overlooks the broader probability-weighted approach that expected value encompasses.