Topic 3 - Part 2: Decision making Under Risk And Uncertainty Flashcards
……. theory is developed as an alternative to EUT to describe decision-making under uncertainty and risk by Khaneman and Tversky (1979).
Prospect
The overall value of an edited prospect, denoted .., is expressed in terms of two scales, .. and ..
V is expressed in terms of two scales, v and π
The first scale, v, - ……. …….. - assigns to each outcome x a number, v(x), which reflects the subjective value of that outcome.
- Outcomes are defined relative to a reference point, which serves as the zero point of the value scale.
Value function
The second scale, π, associates with each probability p a ………. ……. π(p), which reflects the impact of p on the overall value of the prospect.
Decision weight
An essential feature of the Prospect Theory is that the carriers of value are changes in wealth or welfare, rather than ….. ……
Final states
Changes are defined relative to a …….. …, which serves as a zero point of the value scale
Reference point
The variable v measures the value of deviations from that reference point, i.e. …. … ……
Gains and losses
It is often assumed in analysis that the relevant reference point for evaluating gains and losses is the current status of wealth or welfare, but this need not be the case. In particular, the relevant reference point may be the outcome that you ……. or feel entitled.
Expect
Loss aversion - the pain that one experiences in losing a sum of money appears to be …….. than the pleasure associated with gaining the same amount
Greater
The aversiveness of symmetric fair bets generally ………. with the size of the stake. As the size of the stake goes up people are less likely to take it due to loss aversion
Increases.
How to measure the extent of loss aversion? What is the smallest gain that I need to balance and equal change to lose, say, $100?
For many people, the answer is about $200. The loss aversion ratio is here
2.0, the loss aversion ratio has been estimated in experiments and is usually in the range of 1.5 to 2.5 (on average).
The value function for losses is …… than the value function for gains
Steeper
In prospect theory, the value of each outcome is ………. by a decision weight
Multiplied
Decision weights measure the …… of events on the desirability of prospects, and not merely the perceived likelihood of these events.
Impact
subcertainty captures an essential element of peoples
attitudes to uncertain events, namely that the sum of the
weights associated with complementary events is typically
…. than the weight associated with the certain event.
less
People overstate ….. probabilities and understate ….. probabilities.
small / high
In expected utility theory the basic objects of preference are ……. .. …… (including non-monetary resources like health).
states of wealth
In expected utility theory the utility function is …. ….. everywhere. (Most theorists).
risk averse
In expected utility theory …. ……… cannot be defined (expected utility theory does not identify a status quo).
loss aversion
In expected utility theory people evaluate probabilities ……….
linearly
In expected utility theory problem description should have no effect as long as the problem is logically the ….
same
In prospect theory, the basic objects of preference are changes from a …….. ………. …… (gains and losses).
neutral reference point
In prospect theory, the value function is risk …….. for gains, risk ……… for losses
averse / seeking
In prospect theory, the value function implies …. ……..
loss aversion
In prospect theory, people evaluate probabilities ………….
nonlinearly
In prospect theory, problem description can change the reference level; hence the definition of ….. … …… can change.
gains and losses
An investor must choose how long to leave his investments before he evaluates how they are doing. We call this length of time the ………… …….
evaluation period
The volatility of a risky asset can make it undesirable for
someone who is …. ……, even if the overall returns are
high
loss averse
In financial markets, investors prefer to sell stocks that will give them a realised gain (the stocks were sold for more than you paid for them) than to sell stocks that will give them a realised loss (the stocks were sold for less than you paid for them). This is called the ………… ……..
disposition effect
The investor has set up an account for each share that she
bought, and she wants to close every account as a gain. A
rational agent would have a comprehensive view of the
portfolio and …. the stock that is least likely to do well in
the future, without considering whether it is a winner or a
loser
sell
Break-even effect - Risk aversion seems to …….. after
earlier expectations have been shattered by opening
high-value briefcases. (In deal or no deal)
Like horse race bettors who bet on long shots at the
end of the game to try to break even before they go
home.
decrease
House-money effect - risk aversion seems to
………. after earlier expectations have been surpassed by
opening low-value briefcases. (In deal or no deal).
The house money effect forecasts that investors are
more prone to buy higher-risk stocks after a pro table
trade.
decrease
