ECO331H1 Chapter 5: Week 5 Kahneman and Tversky 1979—Prospect Theory An Analysis of Decision under Risk
Document Summary
Expected utility theory; widely accepted model of rational choice. Paper looks at situations in which preferences systematically violate axioms of expected utility theory. Decision making under risk is choice between prospects or gambles. Overall utility of prospect is expected utility of outcomes. Prospect is acceptable if utility from integrating prospect with one"s assets exceeds utility of those assets alone. 50% chance of 1000, 50% of nothing; vs 450 for sure. Questionnaire form, at most a dozen similar questions per booklet. Assumption that people know how they would begave in actual situations of choice and no reason to disguise true preferences. Preference between negative prospects is mirror image of preference between equivalent positive prospects. Risk aversion in positive domain accompanied by risk seeking in negative domain. Certainty increases aversiveness of losses as well as desirability of gains. Prevalence of purchasing insurance regarded by many as strong evidence for concavity of utility function for money.
