This week’s topic is very important because in our everyday life we are constantly making decision and many of these decisions involves certain risks. In most of day by day decision the probabilities are not known by the decision makers, which according to psychologists is known as decisions
under risk and uncertainly. The academics normally express the uncertain events in numeral forms as odds probabilities and is quit difficult to assess the probability of an uncertain event or uncertain quantity. There are limited amount of heuristic principles, which reduces difficult tasks of assessing probabilities and values to a much simpler judgmental operations. However, even though these heuristics are useful they can sometimes lead to errors. Many risky decision making have taken a more quantitative approach and they assume that when individuals make a risky decision in reality what they are trying to do is maximise their expected value and expected utility. According to Hardman (2009), when it comes to expected value theory the probabilities and monetary problems can be determined by calculating the value of each possible outcome and weighting these outcomes by their probability of occurrence. On the other hand the expected theory the individuals are quite happy to pay a large sum of money due to the fact that there is an infinite expected value. Bernoulli (1954) suggested that individuals do not always behave as thought they are maximising expected value this is because while as a person’s wealth increases each extra unit of money adds utility but by less than the previous unit. It’s quite fascinating to learn that expected value theory believes that the rational decision maker should evaluate monetary outcomes by the probability of their occurrence, however, expected utility theory believes that rational decision maker should evaluate utilities of the outcomes by their probability of occurrence. The good thing about this theory (utility) is that it can be applied to other things rather than just money. However, the disadvantage is that it has not being measured directly and the neuroscience evaluation of the theory suggests that dopamine system responds to actual rewards and symbolic information
(suggestion are based on human brain) (Hardman, 2009). Today I have learned that Utility and prospect theory do have things in common such as their integration and maximisation of something. Prospect theory is more concerned about the expectations rather than the monetary values. For example, if I have £10 in my pocket and someone promised to give me £100, however, she decided to give me £50 instead, which means that I am loosing because I expected to receive £100 from that person and I didn’t. Our reference point in prospect theory is our expected value. There is more explanation of the theory than evaluation. The graph below represents my utility function for money values ranging from £0 to £100,000
Fig 1 
Although, the graph suggests risk aversion but i still consider myself rational because i was trying to maximise my expected utility.
Fig 2 
I'm not really sure about the interpretation of the second graph but it seems almost perfect for risk taker.
No comments:
Post a Comment