week9da - Kemal Kl, Sabanc niversitesi Kemal Kl, Sabanc...

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Unformatted text preview: Kemal Kl, Sabanc niversitesi Kemal Kl, Sabanc niversitesi Spring Spring , 2010 , 2010 Decision Analysis MS 405 Risk and Utility Kemal Kl Faculty of Engineering and Natural Sciences Week 8 1 Kemal Kl, Sabanc niversitesi Kemal Kl, Sabanc niversitesi Spring Spring , 2010 , 2010 Risk - Introduction $14.50 Game 1 Game 2 0.5 0.5 0.5 0.5 Payoff $30- $1 $2,000- $1,900 $50.00 Figure 13.1 Which one would you prefer to play? Week 8 2 Kemal Kl, Sabanc niversitesi Kemal Kl, Sabanc niversitesi Spring Spring , 2010 , 2010 Utility Functions Assuming a lottery(game) f with a set of states S and a set of prizes X , a utility function is any function u : X x S-> R (that is, into the real numbers) Note: The utility of a monetary prize of $X, u($X), is not necessarily equal or proportional to |X|, especially when X is a significant portion of the decision makers net worth When X is sufficiently small relative to the current wealth, it is reasonable to assume a linear utility function of the money Week 8 3 Kemal Kl, Sabanc niversitesi Kemal Kl, Sabanc niversitesi Spring Spring , 2010 , 2010 Attitudes Toward Risk An individuals utility function is a mathematical function that transforms monetary values - payoffs and costs - into utility values . Most researchers believe that if certain basic behavioral assumptions hold, people are expected utility maximizers - that is, they choose the alternative with the largest expected utility. (Not always think about framing!) Week 8 4 Kemal Kl, Sabanc niversitesi Kemal Kl, Sabanc niversitesi Spring Spring , 2010 , 2010 Attitudes Toward Risk Week 8 5 Kemal Kl, Sabanc niversitesi Kemal Kl, Sabanc niversitesi Spring Spring , 2010 , 2010 Attitudes Toward Risk An individuals utility function is a mathematical function that transforms monetary values - payoffs and costs - into utility values . Most researchers believe that if certain basic behavioral assumptions hold, people are expected utility maximizers - that is, they choose the alternative with the largest expected utility. (Not always think about framing!) Essentially an individuals utility function specifies the individuals preferences for various monetary payoffs and costs and, in doing so, it automatically encodes the individuals attitudes toward risk. Week 8 6 Kemal Kl, Sabanc niversitesi Kemal Kl, Sabanc niversitesi Spring Spring , 2010 , 2010 Attitudes Toward Risk -- continued Most individuals are risk averse , which means intuitively that they are willing to sacrifice some EMV to avoid risky gambles....
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This note was uploaded on 12/19/2011 for the course ECON Econ203 taught by Professor Majdabpadawnan during the Spring '11 term at University of Maribor.

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week9da - Kemal Kl, Sabanc niversitesi Kemal Kl, Sabanc...

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