The Implications Of Prospect Theory

Kahneman’s article is an analysis of intuitive thinking and how it guides our decision-making. Although primarily aimed at the field of psychology, it is an interdisciplinary article with applications in economic theorising. Kahneman attempts to differentiate between two systems of thought, one of intuition (system 1) and one of reasoning (system 2), and argues that many judgements and choices are made intuitively, rather than with reason (a slower and more deliberate process). Intuitive decision making, which encompasses heuristics, although generally more efficient and rapid, makes the agent potentially subject to errors due to framing effects or violations of dominance. The analysis of the studies and theoretical situations also provides criticism of the commonly held model of the rational agent within economics. The article also further conceptualises Kahneman’s theory, the Prospect Theory (Kahneman & Tversky, 1979), which has descriptive applications of people’s choice in decision-making situations involving risk and known probability of outcomes. These situations are typically unexplained by the more normative rational agent model.

In terms of the anchoring bias, regularly revisit of the original decision based on the newly gathered data needs to be set up within the organization. Additionally, the decision maker should avoid the Confirmation Trap in which Bazerman and Moore (2009) argues that people tend to seek information that confirms their expectations and hypotheses. To recognize the bias, Mike Francis could

The article “Is Tiger Woods Loss Averse? Persistent Bias in the Face of Experience, Competition, and High Stakes” is analyzed which investigate the existence of behavioral bias in a high stake, competitive setting involving experienced agents. It portrays Deming’s System of Profound Knowledge by complying with its four parts. The complete endeavor provides a practical setting to learn decision theory.

C. (1988). Outcome bias in decision evaluation. Journal of Personality and Social Psychology, 54, 569-579.

With attention to the previous information given, the principle of risk-return tradeoff is based on the thought that individuals are opposed to taking risk, meaning individuals would prefer to get a certain return on their investment rather than risking and getting an uncertain return. (Titman, Keown, & Martin, 2014) This principle tells us that investors will receive higher returns for taking on a bigger risk however; a challenge often seen in investors is how to calculate the tradeoff between risks and return with riskier investments. A higher expected rate of return is not always a higher actual return.

As a result, individual expectations, experiences, and biases may influence the way that people view probability of financial events or failures. It is possible to understand that human thinking is impacted by the most important things in life for a person. Fear

An analyst can also reduce their cognitive biases by simply using critical thinking to think through the issue or problem allowing the brain to identify logic, reason and empiricism. Using critical thinking also allows the analyst not to rush into any conclusions or decision that may be wrong or miss leading. Leading to the intelligence to be more precise trustworthy. In since the events of 9/11 could be used as an example of cognitive biases although the threat was there people has a belief that an attack of that magnitude could never happen in America. People only wanted to see what they wanted, end result was that information was potently ignored or

We tend to ignore the final outcome of a decision and focus on the certainty or uncertainty of it. The value we place on winning and losing vary, which is what the Prospect Theory suggests. The Prospect Theory is a model that psychologists created to explain our behavior when it comes to decision making and how we make decisions. Typically, if a decision has to do with a gain, people will lean towards the most certain option because they may fear that if they selected the other option that would be disappointed. On the other hand, decisions that have to do with loses are seen as the opposite by the majority of people. This is because we feel more risky when selecting the uncertain option over the certain option because we are trying to avoid a significant loss. The Prospect Theory provides an explanation on how people make choices under strained conditions of gains and losses in their applications of the real

The problems within the chapter illustrate that we have a tendency towards risk aversion when it pertains to gain while contrarily we become risk seeking when it comes to losses. Even though many of the questions within the chapter were conceptually the same, the contextual framing influenced our decision-making process. Framing can have influential effects on our considerations when we propose solutions. Thus, when we fail to understand that problems can be framed in a variety of ways, we are using imperfect perceptions of probability and it can influence our choices. When one’s focus is only on a particular question, the solution will be based on that framed mindset. While, on the contrary, if a problem can be framed in multiple ways, a truly objective solution can be found.

Confirmation bias describes our unconscious tendency to place more emphasis than necessary on information that is consistent with our own beliefs, hypotheses, and recent experiences and to disregard information that contradicts them (Meissner, Sibony, & Wulf, 2015). Then there is a bias of overconfidence which will cause executives to misjudge their own abilities, as well as the proficiency of the business. This will lead decision makers to imprudently take risks, because they assume they will able to control outcomes. Biases prevented decisions makers from seeing the situation clearly in the case of the BP oil spill. The biases affected the way information was cognitively processed which caused a major lapse in judgment which resulted in

There are many biases that we face each and every day in this world. Some are psychologically and some physically. In this assay a will discuss two biases that people face and deal with. These biases are Self-defeating prophecy and self-fulfilling prophesy. I will discuss the differences and how they impacted one’s life.

Prospect theory is an important alternative descriptive theory for decision-making under unreliable situation (Kahneman and Tversky 1979), which includes real life selection and psychological analysis between choices that involve risk. Prospect theory, which efforts to explain individual make decisions between risky replacements based on the value of potential gains and losses (Wakker 2010), advanced from expected utility theory, which explains that investors want to maximize expected utility of wealth when unclearly situations (Blavatskyy 2007). According to Kahneman and Tversky (1992), more recent researches perceived nonlinear preferences in choices that do not involve definite events in prospective theory. The concept of framing effect refers description invariances (Kahneman and Tversky 1992). To be specific, individual always makes the same decision in identical choice conditions. Also, decision makers have tendency to

According to Simon et al. (1999), human beings who are overconfident tend to take risky actions that are highly likely to give disappointing outcomes due to

Decision making is the act of choosing the best solution to a problem depending on its value and the preferences of the decision maker. In the first part of this essay, we will explore the Expected Utility theory and the Prospect Theory, which are normative and descriptive approaches to making decisions with inherent risks. The first part of the essay argues that Expected Utility Theory is a less viable hypothesis to decision making and is fundamentally flawed compared to the Prospect Theory in description and function. Prospect theory is a better model for decision making because firstly, decisions are not often made objectively and can be affected by decision weights. Secondly, individuals are not risk averse as suggested by the utility theory, but are instead loss averse. Lastly, individuals evaluate decisions not by their final resting utility, but instead they react dependently based on their reference point. The second part of the essay will delve into the topic of heuristics that emerge in investment decision making. The main biases that investors make include disposition effect, anchoring and adjustments bias and overconfidence.

Prospect theory. The theory can be represented by a value function, as shown below. The value function starts from a reference point, and is normally concave for gains, and convex for losses. It is also steeper for losses than for gains. The theory intends to explain why people behave irrationally when making choices.