FNCE 239 Study Guide - Midterm Guide: Biovail, Shortage, Ambiguity Aversion

• School: UPenn
• Department: Finance
• Course: FNCE 239
• Professor: N I K O L A I R O U S S A N O V

Document Summary

Eu theory: typical risk averse (concave) utility function; people make bets based on final wealth (using probabilities and expected value) Prospect theory: pt value = sum of (pi*(p) * v*(x-r)) Prospect theory says that people focus on specific assets instead of the overall wealth portfolio. People aren"t going to value the final value, but rather, changes in wealth (where you are relative to where you started) Loss aversion: people dislike losses 2. 5x as much as they like gains. This can lead to disposition effect/escalation of commitment- you sell winners and hold onto losers (momentum will work against you). You hold onto losers because you don"t want to realize your losses by selling them. If you"re in a domain of losses, you"re reluctant to realize those losses because you"ll gamble and hope that you will recover. Mental accounting/narrow framing- you"re more likely to separate wins and combine losses. Ambiguity aversion- unknown risks are bigger than known risks.