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Prospect Theory II created 2011.01.26

Prospect Theory II created 2011.01.26 - Prospect Theory...

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Prospect Theory Part II

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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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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. outcome-probability pairs) Simplification Rounding
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