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Kahnemann and Tversky Prospect Theory .

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Fundamental Definitions. Definition: Imagine a circumstance with numerous conceivable results where the result is resolved arbitrarily. We allude to this circumstance as a bet or a lottery. We allude to the rundown of conceivable results as occasions. Assume we could rehash the bet a vast number of times. The recurrence with which an occasion happens is its probability.Example: Suppose I have a bingo confine
Transcripts
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﻿Kahnemann and Tversky Prospect Theory Economics 328 Spring 2005

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Basic Definitions Definition: Imagine a circumstance with numerous conceivable results where the result is resolved haphazardly. We allude to this circumstance as a bet or a lottery . We allude to the rundown of conceivable results as occasions . Assume we could rehash the bet a limitless number of times. The recurrence with which an occasion happens is its likelihood . Case: Suppose I have a bingo confine with 60 red balls and 40 green balls in it. I draw one ball from the bingo confine indiscriminately. What are the conceivable occasions? What is the likelihood of every occasion? Occasions = {Red, Green} p(Red) = 60/100 = .6 p(Green) = 40/100 = .4

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Expected Value Definition: Suppose we relate a money related result with every conceivable occasion in a bet. The normal estimation of the bet is the weighted normal of the settlements where the weight for every occasion is its likelihood. All the more formally, let there be n occasions, let p i be the likelihood of occasion i, and let  i be the result connected with occasion i. The accompanying equation gives the normal estimation of the bet. Case: Continuing the past case, assume you gain \$3 if a red ball is drawn and \$1 if a green ball is drawn. What is the normal estimation of the bet?

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Expected Utility Definition: Suppose we consider a person as having an utility capacity over conceivable adjustments from a bet, u(  ). (In fact, we consider an utility capacity over riches. Why is the refinement essential and what does it infer about people\'s basic leadership?) The normal utility of a bet is the normal estimation of the utility. Definition: We say that a person whose minor utility of riches declines as his/her riches rises has diminishing negligible utility from riches. In the event that an individual entirely inclines toward a beyond any doubt thing to a bet with the same expected esteem, we call this individual hazard unfriendly . On the off chance that an individual has diminishing minimal utility from riches and boosts his/her normal utility, he/she should be hazard antagonistic.

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Expected Utility Example: Suppose I offer you the decision between the accompanying two bets: Gamble A: Win \$240 100% Gamble B: Win \$400 50% Win \$100 50% Show that a normal esteem maximizer will pick Gamble B. Demonstrate that a normal utility maximizer with u(  ) =  1/2 will pick Gamble A. EV A = 240

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Kahnemann and Tversky Prospect Theory (1979) Research Questions Expected utility hypothesis epitomizes various solid presumptions. Expected utility is direct in probabilities Preferences are over riches (resource incorporation) instead of additions and misfortunes. Kahnemann and Tversky plan to show various infringement of anticipated that utility hypothesis and would build up an arrangement of observational regularities that educate the improvement of prospect hypothesis. Starting Hypotheses Kahnemann and Tversky expected for find solid infringement of EUT. Kahnemann and Tversky additionally anticipated that would discover a progression of exact regularities in the information. assurance impacts reflection impacts confinement impacts

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Kahnemann and Tversky Prospect Theory (1979) Experimental Design: The examinations reported in this paper depend on a progression of theoretical inquiries asked to Israeli understudies. In every issue, the understudies were solicited to pick between two sets from bets. Their decisions over the different sets are then used to produce infringement. Methodological Questions Are results produced without financial adjustments as solid as results with genuine settlements? Does the extent of the (speculative) stakes assume a substantial part in producing the outcomes? With no technique for evaluating the bets, how expansive are the infringement?

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Common Ratio Problems (additionally because of Allais)

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Common Ratio Problems (likewise because of Allais)

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Reflection Effect

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Reflection Effect

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Isolation Effects

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Isolation Effects

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The Theory of Prospect Theory Editing Phase Coding: Outcomes are coded as increases or misfortunes. The reference indicate can be touchy presentation impacts and desires of the chief. Mix: Prospects with indistinguishable results can be joined. Isolation: now and again, the riskless extent will be disregarded is basic leadership. Cancelation: Common segments will be disposed of in the altering stage. This drives numerous separation impacts.

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The Theory of Prospect Theory Evaluation Phase Each likelihood p has a choice weight,  (p), connected with it. We require that  (0) = 0 and  (1) = 1. Little likelihood occasions are by and large overweighted. This suggests  (p) > p for little estimations of p and  (p) < p for high estimations of p. It require not be valid (and for the most part isn\'t) that  (p) +  (1 – p) = 1. This is known as "subcertainty."

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The Theory of Prospect Theory Evaluation Phase The result is assessed by means of a "value function." This serves much an indistinguishable part from an utility capacity. The esteem capacity is for the most part sunken for increases and curved for misfortunes. This gives us reflection – hazard avoidance over increases and hazard adoring over misfortunes. The esteem capacity is more extreme for misfortunes than for increases, giving us "loss aversion." The general estimation of a bet is given by the accompanying condition for a "regular prospect." regardless of its evident likeness to expected utility, this varies from expected utility in how probabilities are handles and how results are esteemed.

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