Topic 3 - Part 2: Decision making Under Risk And Uncertainty

Question 1

……. theory is developed as an alternative to EUT to describe decision-making under uncertainty and risk by Khaneman and Tversky (1979).

Answer 1

Prospect

Question 2

The overall value of an edited prospect, denoted .., is expressed in terms of two scales, .. and ..

Answer 2

V is expressed in terms of two scales, v and π

Question 3

The first scale, v, - ……. …….. - assigns to each outcome x a number, v(x), which reflects the subjective value of that outcome.
- Outcomes are defined relative to a reference point, which serves as the zero point of the value scale.

Answer 3

Value function

Question 4

The second scale, π, associates with each probability p a ………. ……. π(p), which reflects the impact of p on the overall value of the prospect.

Answer 4

Decision weight

Question 5

An essential feature of the Prospect Theory is that the carriers of value are changes in wealth or welfare, rather than ….. ……

Answer 5

Final states

Question 6

Changes are defined relative to a …….. …, which serves as a zero point of the value scale

Answer 6

Reference point

Question 7

The variable v measures the value of deviations from that reference point, i.e. …. … ……

Answer 7

Gains and losses

Question 8

It is often assumed in analysis that the relevant reference point for evaluating gains and losses is the current status of wealth or welfare, but this need not be the case. In particular, the relevant reference point may be the outcome that you ……. or feel entitled.

Answer 8

Expect

Question 9

Loss aversion - the pain that one experiences in losing a sum of money appears to be …….. than the pleasure associated with gaining the same amount

Answer 9

Greater

Question 10

The aversiveness of symmetric fair bets generally ………. with the size of the stake. As the size of the stake goes up people are less likely to take it due to loss aversion

Answer 10

Increases.

Question 11

How to measure the extent of loss aversion? What is the smallest gain that I need to balance and equal change to lose, say, $100?
For many people, the answer is about $200. The loss aversion ratio is here

Answer 11

2.0, the loss aversion ratio has been estimated in experiments and is usually in the range of 1.5 to 2.5 (on average).

Question 12

The value function for losses is …… than the value function for gains

Answer 12

Steeper

Question 13

In prospect theory, the value of each outcome is ………. by a decision weight

Answer 13

Multiplied

Question 14

Decision weights measure the …… of events on the desirability of prospects, and not merely the perceived likelihood of these events.

Answer 14

Impact

Question 15

subcertainty captures an essential element of peoples
attitudes to uncertain events, namely that the sum of the
weights associated with complementary events is typically
…. than the weight associated with the certain event.

Answer 15

less

Question 16

People overstate ….. probabilities and understate ….. probabilities.

Answer 16

small / high

Question 17

In expected utility theory the basic objects of preference are ……. .. …… (including non-monetary resources like health).

Answer 17

states of wealth

Question 18

In expected utility theory the utility function is …. ….. everywhere. (Most theorists).

Answer 18

risk averse

Question 19

In expected utility theory …. ……… cannot be defined (expected utility theory does not identify a status quo).

Answer 19

loss aversion

Question 20

In expected utility theory people evaluate probabilities ……….

Answer 20

linearly

Question 21

In expected utility theory problem description should have no effect as long as the problem is logically the ….

Answer 21

same

Question 22

In prospect theory, the basic objects of preference are changes from a …….. ………. …… (gains and losses).

Answer 22

neutral reference point

Question 23

In prospect theory, the value function is risk …….. for gains, risk ……… for losses

Answer 23

averse / seeking

Question 24

In prospect theory, the value function implies …. ……..

Answer 24

loss aversion

Question 25

In prospect theory, people evaluate probabilities .............

Answer 25

nonlinearly

Question 26

In prospect theory, problem description can change the reference level; hence the definition of ..... ... ...... can change.

Answer 26

gains and losses

Question 27

An investor must choose how long to leave his investments before he evaluates how they are doing. We call this length of time the ............ .......

Answer 27

evaluation period

Question 28

The volatility of a risky asset can make it undesirable for someone who is .... ......, even if the overall returns are high

Answer 28

loss averse

Question 29

In financial markets, investors prefer to sell stocks that will give them a realised gain (the stocks were sold for more than you paid for them) than to sell stocks that will give them a realised loss (the stocks were sold for less than you paid for them). This is called the ............ ........

Answer 29

disposition effect

Question 30

The investor has set up an account for each share that she bought, and she wants to close every account as a gain. A rational agent would have a comprehensive view of the portfolio and .... the stock that is least likely to do well in the future, without considering whether it is a winner or a loser

Answer 30

sell

Question 31

**Break-even effect** - Risk aversion seems to ........ after earlier expectations have been shattered by opening high-value briefcases. (In deal or no deal) Like horse race bettors who bet on long shots at the end of the game to try to break even before they go home.

Answer 31

decrease

Question 32

**House-money effect** - risk aversion seems to .......... after earlier expectations have been surpassed by opening low-value briefcases. (In deal or no deal). The house money effect forecasts that investors are more prone to buy higher-risk stocks after a pro table trade.

Answer 32

decrease