AFF 502 Chapter Notes - Chapter 3: Risk-Seeking, Risk Aversion, Prospect Theory
1 Jun 2017
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Normative theory: says that reasonable people should act in a certain way. Positive theory: looks at what actually do, and bases models on these observations. Prospect theory because based on how people actually behave. Prospect theory: standard expected utility theory cannot fully account for observed decision-making under risk. Decision (i): choose between p1() and p2(. 25, ,000) Decision (ii): choose between p3(-) and p4(. 75, -) People care about gains/losses rather than level of wealth. Both decisions are the same in terms of probability. The shows it is the change in wealth (rather than level) that matters to people. People evaluate an outcome based on the gain/loss from a reference point usually taken by current wealth. Average response is , clear that people are averse to a loss. Loss aversion: is the term that describes the observation that, for most people, losses loom larger than gains. Prospect theory: provides a model of decision-making under risk that incorporates such observed behaviours.
