Prospect theory

Question 1

Violation 1 (Common ratio effect)

Answer 1

if p=0.8 and other option p=1 choose 1 but if same money choose 0.2 over 0.25 even tho same ratio
violates expected utility theory as should stay consistent

Question 2

Violation 2 (framing effect)

Answer 2

start at 1000 if given p=0.5 to gain 1000 or p=1 to gain 500 choose to gain 500. But if start with 2000 prefer to lose 1000 with p=0.5 over lose 500 with p=1
finale state of 1500 is same for both so EU expects it to be consistent

Question 3

strengths and weaknesses of EU

Answer 3

+- quantitative model allows for precise predictions so allows for empirical tests
X- ignores psychological realism

Question 4

Risk preferences

Answer 4

risk averse for gains
risk seeking for losses
reversed if small probabilities and high values

Question 5

Four-fold pattern of risk preferences

Answer 5

small probabilities and gain -risk seeking (lottery tickets)
small probabilities and loss- risk averse (buying insurance)
medium-high probabilities and gain- risk averse (investing in property)
medium-high probabilities and loss- risk seeking (experimental treatment for serious disease)

Question 6

key modifications of prospect theory

Answer 6

modification to accommodate complex patterns of risk attitudes
- prospects evaluated relative to flexible reference point (highly context specific
-value function for gains and losses
-probabilities distorted
core computation-outcomes to psychological values, multiply by weight and sum up

Question 7

Prospect explaining framing effect

Answer 7

reference point so already banked money so would prefer to lose 1000 at p=0.5 then guarantee lose 500

Question 8

Value function

Answer 8

concave for gains and convex for losses so value function for loss a lot steeper (losses worse then gains) but then tails off
so risk seeking for large losses has less psychological impact

Question 9

Decision weights

Answer 9

probabilities distorted
unlikely events appear more likely
more likely events appear less likely
probabilities transformed into distorted decision weights

Question 10

prospect theory explaining common ratio effect

Answer 10

0.8-1 distance greater then 0.2-0.25 so which appears psychologically similar
underweight 0.8

Question 11

beyond WEIRD judging risk aversion

Answer 11

sure option vs risky option
Chinese and American judge suspected risk aversion for both
expect Americans to be more risk seeking but in actuality Americans more risk averse
cushion hypothesis- collectivist cultures have greater safety net

Question 12

beyond WEIRD loss aversion

Answer 12

lose £80 with p=0.5 and £X p=0.5 need to take deal. measure off loss aversion. Eastern European- most loss averse and African least.
can handle differences between countries as allows for changes in value function slope

Question 13

Beyond WEIRD limitations

Answer 13

cross cultural compassions only compare just a few difference cultures
within-region cultural difference ignored
cultural differences may be confounded by other factors (occupation and wealth)
cultures differ for economic decisions individualism vs collectivism