Week 7 Prospect Theory

Question 1

What is a prospect in Prospect Theory and how many stages are there? Explain them

Answer 1

Prospects are simply potential outcomes and their probability of happening.
There are two stages Editing and Evaluation.
In editing the potential scenarios are outlined, some are condensed together if they have similar outcomes and probability of happening etc
Evaluation is comparing prospects.

Question 2

Explain Hot Hand Effect; Bayesian Theory and Gamblers Fallacy

Answer 2

Hot Hand Effect is when people believe a particular outcome will be more likely to occur due to a previous result despite no change in actual probability.

Bayesian Theory is about incorporating new knowledge with old knowledge to form modern beliefs.

Gamblers Fallacy is if an event happened a lot in the past it is less likely to happen again next, black black black on roulette must mean it will be red next

Question 3

Give the equation for future preference utility

Answer 3

U*(C,S)= (1-alpha)u(C,S)+alphau(C,S’)

Question 4

What is confabulation

Answer 4

Making up events to make the past fit coherently even if those events arent real, done without malicious intent

Question 5

Name two bias’ that can affect decision making

Answer 5

Self evaluation Bias: overestimating your ability; overprecision;overplacement
Confirmatory Bias: Only looking for evidence that confirms your bias
Self Attributing: Ignoring contradictory evidence of your own belief

Question 6

Define prospect theory

Answer 6

People make decisions based relatively on their perceived loss or gain rather than solely on the outcome

Question 7

There are two categories in regulatory focus theory. Explain them

Answer 7

Promotion: associated with hard work, risk, growth
Prevention: associated with stability, focusing on minimising loss

Question 8

Draw the prospect theory utility graph

Answer 8

check in book

Question 9

How does loss aversion affect utility when losing money compared to gaining money

Answer 9

As loss aversion has a heavier weight, utility is lost more if lost than gained

Question 10

Give the equation of the value scale considering outcome is below reference point and outcome is above reference point

Answer 10

(x-r)^alpha if x>r
-upsidedowntriangle(r-x)^beta if x<r