Midterm Flashcards
Stroop Test
Demonstration of interference in the reaction time of a task
stroop test example
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)
Cognitive Reflection Test
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
2-system approach to the cognitive reflection test
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.
System 1 =
automatic, intuitive, impulsive, ever-present
System 2 =
calculating, rational, plodding, effortful
Ex-ante
based on forecasts rather than actual results
ex-post
based on actual results rather than forecasts
Outcome bias
- 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
problem with knowing outcomes
- 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)
outcome bias example
- 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
Hindsight bias
knowing the outcome of an uncertain event raises our perception of how likely we would have thought that the outcome would be ex-ante
example of hindsight bias
“I knew it all along” in reference to predicting who wins a game
“He should have seen it coming” when something goes wrong
how do decision trees help companies?
- 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
Decision node: each decision gets this
The options you have at that decision point generate new separate branches in the tree from the node
Chance node:
uncertainties you face
how do simple trees calculate expected values?
- 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
Classical approach to analyzing decisions under risk
- (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
Prospect Theory to analyzing decisions under risk
- (Kahneman and Tversky)
- Attitudes to risk depend on how our wealth CHANGES from a REFERENCE POINT
- Dislike a loss sharply more than a gain
Diminishing sensitivity
people’s sensitivity to further changes in consumption is smaller for consumption levels that are further away from the reference point
differences between the classical and prospect theory approaches
- 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
Endowment effect
hypothesis that people ascribe more value to things merely b/c they own them
Disposition effect
reluctance to sell an asset that has lost money
Why is the concept of mental accounting important for how we understand the disposition effect?
- 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
Break even effect
you may take risky actions to avoid suffering a loss (sometimes a loss you could not avoid)
difference btw the break even and disposition effects
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
the basic patterns of probability weighting
- 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
example of probability weighting
-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
Can you describe what probability weighting is in intuitive terms, possibly relating it to the System 1 and System 2 metaphor?
- Probability is a System 2 construct - very abstract
- Frequencies evoke images of people and are accessible to System 1
Love of Positive Skewness
- 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
Can you anticipate whether frequency descriptions or probability descriptions will more strongly concept of “affect”?
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)
Availability heuristic
- 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
availability heuristic example
- 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
Anchoring bias
- 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
difference btw availability heuristic and anchoring bias
- 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
affect heuristic
Essentially thoughts are associated with feelings about those thoughts, which affect our decisions
affect heuristic - Kahneman
- the affect heuristic is an instance of subsitution
- Easy question: how do I feel about it?
- Hard question: what do I think about it?
The familiarity test
- have we faced this situation frequently?
- We learn by experience and recognize similarity
- Availability of memory highly influences our intuitions
The feedback test
- did we get reliable feedback in the past?
- Experience requires that we learned the right lessons
The independence test
- are we influenced by inappropriate personal interests or attachments?
- Our subconscious attaches emotional tags to our inferences
The measured emotions test
- 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
What are features of situations where our intuitions formed by availability and affect heuristics are more/less likely to be valuable?
- the familiarity test
- the feedback test
- the independence test
- the measured emotions test
Dan Ariely argues for “four ways companies can create more-sound reward systems”. What are they?
Change the Mindset
Document crucial assumptions
Create a standard for good decision making:
Reward good decisions at the time that they’re made
Change the Mindset
Publicly recognize that rewarding outcomes is a bad idea, particularly for companies that deal in complex and unpredictable environments
Document crucial assumptions
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
Create a standard for good decision making
Good decisions are forward-looking
take available info into account
consider all available options
do not create conflicts of interests
Reward good decisions at the time that they’re made
Reinforce smart habits by breaking the link between rewards and outcomes
e(v)
value (usually $) x probability
Knightian Risk
situations where outcomes are not known but where the probability distributions are
Ex: simulation w/ stock markets, anything that happens in casinos (controlled games)
Knightian Uncertainty
situations where outcomes are not known and the probability distribution is unknown
What is the difference between Risk and Uncertainty as articulated by Frank Knight?
Difference: probability distribution known in Risk but not Uncertainty
What is the “Delphi Technique”?
A process for gathering info from a group and coming to consensus. Frequently used in some form of risk assessments
How is the Delphi Technique designed to help mitigate availability bias and anchoring?
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
What conditions need to be met for “wisdom of the crowds” techniques to work?
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
prediction market
- 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
prediction market example
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
should we use expert risk assessments or public concern to dictate risk-management policymaking ? (Paul Slovic)
- 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
should we use expert risk assessments or public concern to dictate risk-management policymaking ? (Cass Sunstein)
- 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
love canal example
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
Can you describe what an “availability cascade” is?
An availability cascade is a self-reinforcing cycle that explains the development of certain kinds of collective beliefs
