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Optimization of Critical Systems for Robustness in a Multistate World

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Journal: American Journal of Operations Research
ISSN 2160-8830

Volume: 03;
Issue: 01;
Start page: 127;
Date: 2013;
Original page

Keywords: Critical System | Robustness | Risk | Multistate World | Diversification | Hybrid Solution | Portfolio Allocation | Stochastic Optimization | Expected Utility Theory | Minimax Regret | Disappointment Theory

ABSTRACT
Critical systems are typically complex systems that are required to perform reliably over a wide range of scenarios, or multistate world. Seldom does a single system exist that performs best for all plausible scenarios. A robust solution, one that performs relatively well over a wide range of scenarios, is often the preferred choice for reduced risk at an acceptable cost. The alternative with the maximum expected utility may possess vulnerabilities that could be exploited. The best strategy is likely to be a hybrid solution. The von Neumann-Morgenstern Expected Utility Theory (EUT) would never select such a solution because, given its linear functional form, the expected utility of a hybrid solution cannot be greater than that of every constituent alternative. The continuity axiom and the independence axiom are assessed to be unrealistic for the problem of interest. Several well-known decision models are analyzed and demonstrated to be potentially misleading. The linear disappointment model modifies EUT by adding a term proportional to downside risk; however, it does not provide a mathematical basis for determining preferred hybrid solutions. The paper proposes a portfolio allocation model with stochastic optimization as a flexible and transparent method for defining choice problems and determining hybrid solutions for critical systems with desirable properties such as diversification and robustness.
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