Uncertainty

Question 1

What is Expected Utility Theory ?

Answer 1

Expected utility theory suggests that choices are coherently and consistently made by weighing outcomes (gains or losses) of actions (alternatives) by their probabilities (with payoffs assumed to be independent of probabilities). The alternative which has the maximum utility is selected (Einhorn and Hogarth, 1981).

Question 2

What are the issues with Expected Utility Theory ?

Answer 2

Expected utility theory does not allow for influences on choice due to characteristics of the context of the decision.

Question 3

What is Prospect Theory ?

Answer 3

Decision makers prefer to simplify their choices cognitively whenever possible, satisficing rather than maximizing.

Two stages:

1. Framing
2. Evaluating

Question 4

What are the violations of EUT that Prospect theory Suggests?

Answer 4

1. They tend to be risk averse toward adjustments seen as gains, and risk seeking toward adjustments seen as losses from this point.
2. Decision makers tend to overweight unlikely events and underweight likely events when assigning probabilities.
3. Finally, the manner in which alternatives are presented can influence the choices made.

Question 5

What is regret Theory?

Answer 5

Regret theory centers on the fact that people are afraid of making wrong choices, and so the fear of regret drives suboptimal decisions. And regret theory works in both directions – making some people more risk-averse and protective, and others more aggressive due to ‘fear of missing out.’

Question 6

Creator of EUT?

Answer 6

Von Neumann and Morgenstern

Question 7

Creator of Prospect Theory?

Answer 7

Tversky and Kahneman

Question 8

Creator of regret Theory

Answer 8

Loomes, Sugden and Bell