risk and uncertainty
I was talking with a friend over lunch and was surprised that she had never heard of prospect theory:
Kahneman and Tversky's Prospect Theory
Daniel Kahneman and Amos Tversky called their studies of how people manage risk and uncertainty Prospect Theory for no other reason than that it is a catchy, attention-getting name.
Kahneman and Tversky started their research investigating apparent anomalies and contradictions in human behavior. Subjects when offered a choice formulated in one way might display risk-aversion but when offered essentially the same choice formulated in a different way might display risk-seeking behavior. For example, as Kahneman says, people may drive across town to save $5 on a $15 calculator but not drive across town to save $5 on a $125 coat.
One very important result of Kahneman and Tversky work is demonstrating that people's attitudes toward risks concerning gains may be quite different from their attitudes toward risks concerning losses. For example, when given a choice between getting $1000 with certainty or having a 50% chance of getting $2500 they may well choose the certain $1000 in preference to the uncertain chance of getting $2500 even though the mathematical expectation of the uncertain option is $1250. This is a perfectly reasonable attitude that is described as risk-aversion. But Kahneman and Tversky found that the same people when confronted with a certain loss of $1000 versus a 50% chance of no loss or a $2500 loss do often choose the risky alternative. This is called risk-seeking behavior. This is not necessarily irrational but it is important for analysts to recognize the asymmetry of human choices.
Peter Bernstein cites an experiment by Richard Thaler in which student were told to assume they had just won $30 and were offered a coin-fip upon which they would win or lose $9. Seventy percent of the students opted for the coin-flip. When other students were offered $30 for certain versus a coin-flip in which they got either $21 or $39 a much smaller proportion, 43%, opted for the coin-flip.
Source: Peter Bernstein, Against the Gods: The Remarkable Story of Risk, John Wiley & Sons, New York, 1996.
Kahneman and Tversky's Prospect Theory
Daniel Kahneman and Amos Tversky called their studies of how people manage risk and uncertainty Prospect Theory for no other reason than that it is a catchy, attention-getting name.
Kahneman and Tversky started their research investigating apparent anomalies and contradictions in human behavior. Subjects when offered a choice formulated in one way might display risk-aversion but when offered essentially the same choice formulated in a different way might display risk-seeking behavior. For example, as Kahneman says, people may drive across town to save $5 on a $15 calculator but not drive across town to save $5 on a $125 coat.
One very important result of Kahneman and Tversky work is demonstrating that people's attitudes toward risks concerning gains may be quite different from their attitudes toward risks concerning losses. For example, when given a choice between getting $1000 with certainty or having a 50% chance of getting $2500 they may well choose the certain $1000 in preference to the uncertain chance of getting $2500 even though the mathematical expectation of the uncertain option is $1250. This is a perfectly reasonable attitude that is described as risk-aversion. But Kahneman and Tversky found that the same people when confronted with a certain loss of $1000 versus a 50% chance of no loss or a $2500 loss do often choose the risky alternative. This is called risk-seeking behavior. This is not necessarily irrational but it is important for analysts to recognize the asymmetry of human choices.
Peter Bernstein cites an experiment by Richard Thaler in which student were told to assume they had just won $30 and were offered a coin-fip upon which they would win or lose $9. Seventy percent of the students opted for the coin-flip. When other students were offered $30 for certain versus a coin-flip in which they got either $21 or $39 a much smaller proportion, 43%, opted for the coin-flip.
Source: Peter Bernstein, Against the Gods: The Remarkable Story of Risk, John Wiley & Sons, New York, 1996.
Powered by ScribeFire.
0 comments:
Post a Comment