How do scenario trees differ from fold back in terms of probability handling?

• A. They ignore probabilities
• B. They use backward induction
• C. They multiply scenario tree probabilities sequentially down the branches in a forward fashion
• D. They consider probabilities but not sequences

Answer: (C)

In a scenario tree, probabilities are handled by forward propagation along each path. The probability of a complete sequence of events (a specific path from root to leaf) is the product of the branch probabilities encountered along that path. This front-to-back multiplication gives you the likelihood of every possible scenario and lets you weight outcomes accordingly.

Fold back, by contrast, relies on backward induction. You start at the leaves and work back toward the root, using the branch probabilities to form weighted averages or expected values at each node. The emphasis is on aggregating values from future outcomes back to inform present decisions, not on multiplying probabilities along forward paths to form path probabilities.

So the key difference is forward multiplication of branch probabilities to obtain path probabilities in scenario trees, whereas fold back uses backward induction to compute expectations from bottom up.