wk 9 cog Flashcards
types of choices
riskless multiattribute choice (choose between dif cans of soup, have multiple attributes but no risk)
Intertemporal Choice - choose an option now or future option
Decisions under uncertainty (don’t know probability)
Decision under risk (do know probability)
expected value calculation
(of a decision)
sum of each possible outcome weighted by its probability
e.g. 80% chance of getting £4000 would be 0.8 x 4000 + 0.2 x £0 = £3200
people are risk averse when it comes to
gains.
e.g. they would take 100% chance of £3000 rather than 80% chance of £4000
expected utility theory
Less ratioal, takes int account how good smth makes you feel.
How good it makes you feel (y) against the gain (x) [£]
Concave function. starts of steep, gets a bit shallower
e.g. if u get £3000 will feel good. if get another £1000 to make £4000 it won’t feel as good
so let’s say getting £3000 gives you 122 utility points and £4000 gives 145.
80% chance of getting £4000 would be 0.8 x 145 = 116
and a 100% chance of getting £3000 would be 1.0 x 122 = 122
122>145 so according to utility theory, b is better option
violations of expected utility theory
theory does not hold for negatives.
prospect theory graph
describe
very similar to utility theory, except adds a negative section for loss.
In the loss section, the graph is a lot steeper. indicates subjective feeling is greater (worse) when losing a value of money compared to the positive of gaining the money = Loss aversion
in jargon:
- diminshing sensitivity to gain
- diminishing sensitivity to loss, but steeper
prospect theory summary
-there is an editing phase (rounding, processes number)
-reference point (how much money u have)
-Value
- Decision weights
endowment effect in prospect theory
study
3 groups
group 1 start with nothing
group 2 start with mug
group 3 start with chocolate
both asked would they rather have a (keep for group 2) mug or a (keep for group 3) chocolate
Found to be equal in group 1
Group 2, 89% chose to keep the mug.
Group 3, 10% chose mug
explained as a loss would feel worse than a gain. once take ownership, has more value.
risk attitudes in prospect theory
risk averse for perceived gains
risk seeking for perceived losses
certainty effects and non - linear probabilities
1) A: 5% chance to win smth better or B: 10% chance for smth worse
vs
2) A: 50% chance of smth better
B: 100% chance of smth worse
same outcomes, same difference between probability, BUT diff choices
e.g. 67% chose 1A but 78% chose 2B
non linear probailities=
people will choose to increase 5% to 10% instead of increasing 30% to 35%
AND
will choose to increase 90% to 95% over 65 to 70%.
descision
prospect theory: weight function
overweight small probabilities, underweight large probabilities
e.g. ppl percieve smaller probabilities to be larger than they are
2 problems with prospect theory
- limited scope
can’t explain valuation vs choice or attraction effect - purely descriptive
problems with prospect theory:
choice vs valuation
Choice vs Valuation
two choices:
one with higher probability of winning (p-bet) , one with increased money ($ bet)
then once made the choice, they are told to place a value on each bet (sell each bet)
73 % p.p who chose the p-bet then rate the $ bet as higher value
SO, it depends on how the question is asked (which would you choose vs which is higher value).
prospect theory can’t explain this
e.g. [A 95% chance to win $2.50 and a 5% chance to lose $0.75
= P-bet
A 40% chance to win $8.50 and a 60% chance to lose $1.50
= $-bet]
[then p.p told
An hour later… You own a ticket for this bet.
What is your minimum selling price?]
[73% of pp who chose the p bet sell the $ bet for a higher price]
problems with prospect theory: limited scope
Attraction effect
Option A. 40% chance of $25
Option B. 30% chance of $33
Option C. 40% chance of $20
(60% CHOOSE A)
Option A. 40% chance of $25
Option B. 30% chance of $33
Option C. 25% chance of $33
(75% CHOOSE B)
e.g. the irrelevant option makes the similar option more attractive
Prospect theory as purely descriptive
descision by sampling.
sampled bank accounts gains and loss.
Prospect theory doesn’t care waht teh processes are, just describes
what does descision by sampling tell us about prospects theory
if we look at financial and probabilistic environment we’re working in, it produces curves that look just like
tells us about cognition.
better than prospect theory
