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Prospect Theory
Part II
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View Full Document Probability Weighting
•
What we can explain with the introduced value
function?
–
Framing effects
–
Reflection effects
•
What about Allais Paradox (common ratio, and
common consequence effects)
–
Recall the common ratio effect example:
A
B
($4000, .80)
($3000)
20%
80%
C
D
($4000, .20)
($3000, .25)
65%
35%
•
What about the following experimental result?
A’
B’
($5000, .001)
($5)
72%
28%
C’
D’
($5000, .001)
($5)
17%
83%
Fourfold pattern of risk aversion
Gains
Losses
Small
probability
V() concave
RA
→
Probability overweighting
→
RS
Risk seeking behavior in
lotteries
($5000, 0.001) vs ($5)
V() convex
RS
→
Probability overweighting
RA
→
Risk averse behavior in insurance
($5000, 0.001) vs ($5)
Moderate/high
probability
V() concave
RA
→
Probability underweighting
→
RA
Risk averse behavior
V() convex
RS
→
Probability underweighting
RS
→
Risk seeking behavior
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View Full Document Editing Phase
•
Editing
–
Coding
•
Gain or loss
–
Combination
•
combine the probabilities of the same outcomes
–
Segregation
•
riskless component segregated from risky component
–
Cancellation
•
Discarding of components shared by the offered prospects
–
Problem 10, problem 11 and 12
•
Discarding of common constituents (e.g. outcomeprobability pairs)
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This note was uploaded on 04/15/2011 for the course ECON 73348 taught by Professor Hafalir during the Spring '11 term at Carnegie Mellon.
 Spring '11
 hafalir

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