Utility theory

Question 1

what is utility theory

Answer 1

Utility theory is a concept in behavioral finance that seeks to explain how people make decisions under uncertainty and risk. The theory proposes that people have a utility function, which is a mathematical representation of their preferences and attitudes toward risk. The utility function assigns a numerical value, or utility, to each possible outcome of a decision, and people make choices that maximize their expected utility.

Utility theory is an important concept in behavioral finance, as it helps to explain why people make certain decisions when faced with uncertainty and risk. By understanding how people value different outcomes, investors can make more informed decisions and avoid common biases and errors.