Midterm

Question 1

Stroop Test

Answer 1

Demonstration of interference in the reaction time of a task

Question 2

stroop test example

Answer 2

Color example: When the name of a color is printed in a color which is not denoted by the name, naming the color of the word takes longer (system 2) and is more prone to errors than when the color of the ink matches the name of the color (system 1)

Question 3

Cognitive Reflection Test

Answer 3

a task designed to measure a person’s tendency to override an incorrect “gut” response and engage in further reflection to find a correct answer

Question 4

2-system approach to the cognitive reflection test

Answer 4

The cognitive reflection test has three questions that each have an obvious but incorrect response given by system 1. The correct response requires the activation of system 2. For system 2 to be activated, a person must note that their first answer is incorrect, which requires reflection on their own cognition.

Question 5

System 1 =

Answer 5

automatic, intuitive, impulsive, ever-present

Question 6

System 2 =

Answer 6

calculating, rational, plodding, effortful

Question 7

Ex-ante

Answer 7

based on forecasts rather than actual results

Question 8

ex-post

Answer 8

based on actual results rather than forecasts

Question 9

Outcome bias

Answer 9

• the outcome of a decision is used to judge the quality of the decision making process that lead to the outcome
• Bad outcomes generate more negative views of the decision that good outcomes, even when the decision process can lead to either outcome

Question 10

problem with knowing outcomes

Answer 10

• can make it difficult to judge the quality of the decision, even if that is what you are explicitly asked to do (outcome)
• can make it difficult to recognize how surprising it would’ve been (hindsight)

Question 11

outcome bias example

Answer 11

• Winning a prize either take $200 for sure or 80% chance of winning $300 20% getting nothing and he must mail in his decision in advance and will be told the outcome later
• If he chooses the bet and gets nothing - really negative outcome bias
• If he chooses $200 and sees that he would have gotten $0 with the bet - really positive outcome bias

Question 12

Hindsight bias

Answer 12

knowing the outcome of an uncertain event raises our perception of how likely we would have thought that the outcome would be ex-ante

Question 13

example of hindsight bias

Answer 13

“I knew it all along” in reference to predicting who wins a game
“He should have seen it coming” when something goes wrong

Question 14

how do decision trees help companies?

Answer 14

• Laying out contingencies and processes reveals blind spots
• Forces concrete discussion of objective and value of outcomes
• Makes decisions more objective and might diffuse emotions

Question 15

Decision node: each decision gets this

Answer 15

The options you have at that decision point generate new separate branches in the tree from the node

Question 16

Chance node:

Answer 16

uncertainties you face

Question 17

how do simple trees calculate expected values?

Answer 17

• Simple trees work by calculating expected values at each branching spot for the rest of the tree going forward from there
• Computerized trees will then tell you at each decision node to choose the path with the highest expected value

Question 18

Classical approach to analyzing decisions under risk

Answer 18

• (Bernoulli)
• Risk aversion comes from the diminishing marginal utility of wealth b/c utility increases more from low to moderate than from moderate to high
• What matters is the LEVEL of final wealth
• Otherwise do a rational expected utility calculation using best probabilities
• L(n) function in excel assignment

Question 19

Prospect Theory to analyzing decisions under risk

Answer 19

• (Kahneman and Tversky)
• Attitudes to risk depend on how our wealth CHANGES from a REFERENCE POINT
• Dislike a loss sharply more than a gain

Question 20

Diminishing sensitivity

Answer 20

people’s sensitivity to further changes in consumption is smaller for consumption levels that are further away from the reference point

Question 21

differences between the classical and prospect theory approaches

Answer 21

• Classical really only cares about the final consequences, prospect cares about changes relative to a reference point (which can change)
• Prospect theory cannot deal with disappointment

Question 22

Endowment effect

Answer 22

hypothesis that people ascribe more value to things merely b/c they own them

Question 23

Disposition effect

Answer 23

reluctance to sell an asset that has lost money

Question 24

Why is the concept of mental accounting important for how we understand the disposition effect?

Answer 24

• What we experience as a loss depends on when we close our mental accounts
• If you leave the mental account open, you may not have to “realize the loss”
• Gives an incentive to hold onto assets in the hope they recover

Question 25

Break even effect

Answer 25

you may take risky actions to avoid suffering a loss (sometimes a loss you could not avoid)

Question 26

difference btw the break even and disposition effects

Answer 26

Disposition is more a reluctance to complete a transaction that makes you feel a loss if you can wait and possibly avoid that feeling, where as the break even effect usually triggers after a loss has occurred and you take a risk to get back some of that loss and break even

Question 27

the basic patterns of probability weighting

Answer 27

• When the chance of gaining something is relatively low, people tend to take that chance
• When the chance of gaining something is relatively high, people tend to take the sure thing, not the chance
• $ amounts need to be significantly lower for the first one and higher for the second

Question 28

example of probability weighting

Answer 28

-Version 1: 5% chance of $100 vs. $5 for sure (Hope to gain)
50% picked the first option, 50% picked the second
-Version 2: 75% chance of $100 vs. $75 for sure (Fear of loss)
10% picked the first, 90% picked the second

Question 29

Can you describe what probability weighting is in intuitive terms, possibly relating it to the System 1 and System 2 metaphor?

Answer 29

• Probability is a System 2 construct - very abstract

- Frequencies evoke images of people and are accessible to System 1

Question 30

Love of Positive Skewness

Answer 30

• People who have strong probability weighting overvalue these stocks
• Overweighting a small probability (this company will be the next Google)
• When a lot of people overweight, it cause an overvalue in, for example, stocks

Question 31

Can you anticipate whether frequency descriptions or probability descriptions will more strongly concept of “affect”?

Answer 31

Turkey Pox Example
People took the drug that could cause an allergic reaction leading to death less when it showed a frequency (every 3 out of 1000) rather than a probability (0.3)

Question 32

Availability heuristic

Answer 32

• When making a decision we look to what is top of mind or readily available to do so
• Can depend on:
  - Emotional things
  - How recent an event happened
  - Personal experiences or memories

Question 33

availability heuristic example

Answer 33

• Should nuclear power be a part of energy policy?
• If you think of Fukushima happening - no, too dangerous
• If you think of the threat of climate change - yes, it’s better than fossil fuels

Question 34

Anchoring bias

Answer 34

• tendency to rely too heavily on the first piece of info offered (either outside force or by thought process) when making decisions
• Power of suggestion and mental images - adjustment process in deliberative judgement

Question 35

difference btw availability heuristic and anchoring bias

Answer 35

• Closely linked to availability heuristic - but anchors can be introduced by outside forces - someone could spit a fact and you would use that as your anchor
• Whereas the availability heuristic is what YOU remember on your own

Question 36

affect heuristic

Answer 36

Essentially thoughts are associated with feelings about those thoughts, which affect our decisions

Question 37

affect heuristic - Kahneman

Answer 37

• the affect heuristic is an instance of subsitution
  
  • Easy question: how do I feel about it?
  • Hard question: what do I think about it?

Question 38

The familiarity test

Answer 38

• have we faced this situation frequently?
• We learn by experience and recognize similarity
• Availability of memory highly influences our intuitions

Question 39

The feedback test

Answer 39

• did we get reliable feedback in the past?

- Experience requires that we learned the right lessons

Question 40

The independence test

Answer 40

• are we influenced by inappropriate personal interests or attachments?
• Our subconscious attaches emotional tags to our inferences

Question 41

The measured emotions test

Answer 41

• are the emotions we have experienced in similar or related situations measured?
• All memories come with emotional tags, but some are more highly charged that others

Question 42

What are features of situations where our intuitions formed by availability and affect heuristics are more/less likely to be valuable?

Answer 42

• the familiarity test
• the feedback test
• the independence test
• the measured emotions test

Question 43

Dan Ariely argues for “four ways companies can create more-sound reward systems”. What are they?

Answer 43

Change the Mindset
Document crucial assumptions
Create a standard for good decision making:
Reward good decisions at the time that they’re made

Question 44

Change the Mindset

Answer 44

Publicly recognize that rewarding outcomes is a bad idea, particularly for companies that deal in complex and unpredictable environments

Question 45

Document crucial assumptions

Answer 45

Analyze a manager’s assumptions at the time when the decision takes place. If they are valid but circumstances change, don’t punish her, but don’t reward her either

Question 46

Create a standard for good decision making

Answer 46

Good decisions are forward-looking
take available info into account
consider all available options
do not create conflicts of interests

Question 47

Reward good decisions at the time that they’re made

Answer 47

Reinforce smart habits by breaking the link between rewards and outcomes

Question 48

e(v)

Answer 48

value (usually $) x probability

Question 49

Knightian Risk

Answer 49

situations where outcomes are not known but where the probability distributions are
Ex: simulation w/ stock markets, anything that happens in casinos (controlled games)

Question 50

Knightian Uncertainty

Answer 50

situations where outcomes are not known and the probability distribution is unknown

Question 51

What is the difference between Risk and Uncertainty as articulated by Frank Knight?

Answer 51

Difference: probability distribution known in Risk but not Uncertainty

Question 52

What is the “Delphi Technique”?

Answer 52

A process for gathering info from a group and coming to consensus. Frequently used in some form of risk assessments

Question 53

How is the Delphi Technique designed to help mitigate availability bias and anchoring?

Answer 53

Basic Process:
Develop a survey instrument with measurable questions
Distribute it and get anonymous feedback from variety of experts and stakeholders
Share a summary of results
Group discusses, absorbs, shares feedback
Often narrow the focus and repeat the process

Question 54

What conditions need to be met for “wisdom of the crowds” techniques to work?

Answer 54

The crowd needs to have relevant info
-Like in sports or elections
The crowd needs some independence in their info
-If everyone draws from the same info = shared bias
Symmetry in errors
-Positive errors balance negative errors

Question 55

prediction market

Answer 55

• A market setup for people to trade “shares” in the outcome of an uncertain event
• Shares payoff in a defined way based on the outcome
• The market price can reveal a prediction of the likelihood of occurrence when tied to a discrete event

Question 56

prediction market example

Answer 56

betting on a sporting event (3 point advantage)

• Price adjusts to reflect the average belief
• If too many bets are in favor of the 3 point advantage, adjust the price to make the other bet more favorable

Question 57

should we use expert risk assessments or public concern to dictate risk-management policymaking ? (Paul Slovic)

Answer 57

• Prefers listening to public concern when dealing with policy making because experts usually measure risks by the number of lives lost whereas the public has more specific distinctions like “good deaths” vs. “bad deaths” or death by random accidents vs death doing a voluntary activity like skiing
• Public is guided by emotion

Question 58

should we use expert risk assessments or public concern to dictate risk-management policymaking ? (Cass Sunstein)

Answer 58

• Argues the availability cascade and for that reason experts are better
• The public blows a small concern out of proportion resulting in government action needing to take place
• love canal example

Question 59

love canal example

Answer 59

Example: Love Canal
Toxic waste exposed during rainy season causing contamination of water over the standard limit and had a bad smell
Residents were scared and angry
This resulted in daily stories about the Love Canal
Scientists trying to say that the dangers were overstated and not as bad as it seems were ignored
ABC News airs The Killing Ground
Empty baby-sized coffins are paraded in front of legislature
Some residents were relocated at the government’s expense
CERCLA legislation for toxic cleanup was established

Question 60

Can you describe what an “availability cascade” is?

Answer 60

An availability cascade is a self-reinforcing cycle that explains the development of certain kinds of collective beliefs