5 - implication of CRE and dynamic choice

Question 1

what is dynamic choice problem under risk

Answer 1

a choice problem where outcome determined by combination of choices and risks

Question 2

what were the phenomena seen in static choices under risk

Answer 2

CRE
CCE

Question 3

how are dynamic decision problems represented

Answer 3

using decision trees
assumes that decision making satisfies frame independence

Question 4

what are the 4 principles of rational dynamic decision making

that are imposed in orthodox economic modelling

Answer 4

1. frame independence
2. forward looking rationality
3. dynamic consistency
4. reduction of compound lotteries

Question 5

what is frame independence

Answer 5

same decision tree = agent will make same choices

• any 2 dynamic decision problems that have the same decision tree - the agent will make the same decisions
• trees capture all relevant factors

Question 6

what is a compound lottery

Answer 6

lottery that leads to another lottery as an outcome

Question 7

what is standard reduction of compound lotteries

Answer 7

• rational agent will reduce compound lottery to a probabilistically equivalent simple lottery by multiplying the probabilities out

Question 8

what is forward looking rationality

Answer 8

you should be forward looking and make the same decisions at the choice node no matter where it is positioned

rational decision makers should be forward looking

Question 9

what is dynamic consistency

Answer 9

plan ahead and dont change plans unless new unpredictable info

a rational agent should plan ahead and not change their plans unless there is new info whose arrival was unpredictable

Question 10

what does equivalent trees mean

Answer 10

will make the same decisions in both trees

Question 11

if a rational agent obeys standard reduction principle of compound lotteries what does this mean

Answer 11

they will make the same choices in tree with compound lottery and equivalent tree where the compound lottery has been multiplied out

Question 12

if a rational agent obeys forward looking principle what does this mean

Answer 12

if 2 trees that have, and tree 1 is identical to subtree of tree 2 that starts with choice node

then agents choices at that node are the same for both trees - equivalence of trees

• by forward looking the trees are equivalent

Question 13

if a rational agent obeys dynamic consistency what does this mean

Answer 13

at earlier choice nodes they know what the will do at later choice nodes because they can plan ahead
will do same thing at n2 that you planned you would do at n1 for n2

Question 14

what has the CRE have to do with the 4 principles of rational dynamic decision making

what does this mean

Answer 14

it is impossible to have CRE preferences while satisfying all of the principles

casts doubt on the adequacy of the orthodox dynamic choice principles

Question 15

if you satisfy frame independence then

Answer 15

dynamic choice behaviour can be analysed in decision trees

Question 16

so what does evidence of CRE mean

Answer 16

that we cant trust the principles - cant all hold at the same time if CRE is present

Question 17

what is the CRE - and the problems

Answer 17

tendency to switch from safe to risky option when chances of winning is scaled down by common ratio
problem 1: scaled up
problem 2: scaled down - choose risky

Question 18

why can CRE happen?

Answer 18

if CRE - the would switch from safe to risky

• but if all of the principles are true doesnt suggest that you can switch - suggests you will always choose down - not switch

Question 19

if a agent does satisfy all the principles what does this mean for CRE context

Answer 19

they will either choose up in every choice node in trees 1 - 4

or they will either choose down

trees are all equivalent - from small changes

this is inconsistent with CRE preferences