Behavioral Economics Principles Quiz

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Questions and Answers

What principle is violated by the common ratio effect?

The law of large numbers

Expected utility theory (EUT) (correct)

The principle of dominance

The principle of risk aversion

Which theories can explain the common ratio effect through non-linear probability weighting?

Markowitz and EUT

Behavioral economics and traditional utility theory

Dual-EU, dual M-EU, and prospect theory (PT) (correct)

Utility theory and risk-return analysis

In traditional expected utility theory, what aspect of probabilities is primarily considered?

The average of probabilities

The absolute values of outcomes

The sum of probabilities

The ratio of probabilities (correct)

What would be a correct representation under probability transformation for two probabilities p and q?

w (–p)/w (–q) = w (p)/w (q) Signup and view all the answers

What is the primary flaw in Markowitz's theory regarding the common ratio effect?

It cannot accommodate violations of linearity in probabilities. Signup and view all the answers

Which country is NOT listed in the context regarding changes in sensitivity for gains?

Argentina Signup and view all the answers

What type of sensitivity is observed in the listed countries?

Sensitivity for gains Signup and view all the answers

Which country appears first alphabetically in the list?

Belgium Signup and view all the answers

Which of the following countries has an alpha value potentially influencing gains, according to the context?

Ethiopia Signup and view all the answers

How many countries, including the United States, are mentioned in the list?

22 Signup and view all the answers

Which of the following countries is located in Europe as per the content?

Spain Signup and view all the answers

What characteristic is related to the mean of alpha mentioned in the content?

Changes in sensitivity for gains Signup and view all the answers

Which country is NOT part of the list under the Decision Theory context?

Ukraine Signup and view all the answers

What is the primary focus of prospect theory as introduced by Kahneman and Tversky?

To integrate elements from M-EU and Dual-EU Signup and view all the answers

In prospect theory, how are probabilities transformed in relation to decision-making?

Probabilities are subjectively transformed into decision weights Signup and view all the answers

What does the reflection aspect of prospect theory describe?

Small probabilities are over-weighted and large probabilities underweighted Signup and view all the answers

How is utility characterized in prospect theory for gains and losses?

It is concave for gains and convex for losses Signup and view all the answers

What does gain-loss separability imply about mixed prospects in decision-making?

Gains, losses, and mixed prospects can be represented differently Signup and view all the answers

What is a key feature of the loss aversion parameter in prospect theory?

It modifies the relationships in the decision weights formulation Signup and view all the answers

Which statement best describes the violations of M-EU and Dual-EU mentioned in the content?

They fail to explain variances in certain simple settings Signup and view all the answers

According to prospect theory, what happens to the perception of losses compared to gains?

Losses loom larger than gains Signup and view all the answers

What is the equity premium puzzle primarily concerned with?

Higher returns to shares compared to options Signup and view all the answers

Which theory can explain the equity premium puzzle with the addition of myopic loss aversion?

Cumulative Prospect Theory Signup and view all the answers

What does myopic loss aversion refer to?

The evaluation of decisions in isolation causing loss avoidance Signup and view all the answers

Which principle explains the fallacy of overlooking aggregated choices over a lifetime?

Narrow framing principle Signup and view all the answers

In the urn scenario, what is typically preferred by most people?

Betting on the urn with the known proportion of colors Signup and view all the answers

What is ambiguity aversion characterized by in choice behaviors?

Favoring known probabilities over unknown ones Signup and view all the answers

How can the pattern of ambiguity aversion be generalized?

It adjusts with more colors of known or unknown proportions Signup and view all the answers

What is the contradiction presented by ambiguity aversion concerning subjective expected utility theory?

Preference for certainty over maximizing expected value Signup and view all the answers

What does Prospect Theory combine to address decision-making under risk?

Probability distortions and reference dependence Signup and view all the answers

Which of the following effects is not a part of the paradoxes revisited in the context of Prospect Theory?

Sunk cost effects Signup and view all the answers

How does dual expected utility (dual-EU) violate when considering changes in outcomes?

By presenting inconsistent preferences across stakes Signup and view all the answers

What does the discounted utility model proposed by Samuelson assume about the discount function D(t)?

D(t) is exponential with constant discounting. Signup and view all the answers

What happens to relative risk aversion as stakes increase up to £10,000?

It increases slowly over stakes Signup and view all the answers

Which of the following is a key implication of the discounted utility model regarding time?

Only absolute differences in time matter. Signup and view all the answers

Which statement accurately reflects the relationship between dual-EU violations and stakes when they become large?

Violations of dual-EU become more important as stakes exceed £10 million Signup and view all the answers

In the discounted utility formula, what do the variables 'ys' and 'xt' represent?

They denote future consumption choices and their timing. Signup and view all the answers

What is a limitation of Prospect Theory regarding gain-loss separability?

It does not account for outcomes in terms of a reference point Signup and view all the answers

Which concept is not a component of dual expected utility (dual-EU)?

Probability weighting Signup and view all the answers

What is the functional form of the discount function D(t) in continuous time as proposed in the model?

D(t) = exp(−rt) Signup and view all the answers

What effect is demonstrated when people's choices are influenced by how options are presented?

Framing effect Signup and view all the answers

What does the equation DU(x1, t1;...; xT, tT) represent in the context of discounted utility?

The cumulative utility of all future consumption values. Signup and view all the answers

Study Notes

Decision Theory - Part II

Prospect Theory for Risk and Uncertainty is discussed.
Markowitz-EU is contradicted by probability variations and stake variations.
Prospect Theory combines probability distortions and reference dependence.
Prospect Theory considers more than two outcomes (good news probabilities and rank-dependence).
The presentation revisits paradoxes such as framing, common ratio, and common consequence effects; lottery and insurance, equity premium puzzle; and response mode and Ellsberg paradoxes.
Prospect theory has limitations, including gain-loss separability, rank dependence, and the reference point.
A case study is presented to evaluate if preferences are stable, considering environmental adaptability.
The dual expected utility is examined.
The relationship between dual-EU and the primal is discussed.
Violations of the dual-EU are described.
The relationship between stakes and relative risk aversion is discussed in relation to dual-EU and Markowitz-EU.
Violations of the Markowitz-EU that are more severe, than those for the dual-EU are highlighted when stakes are moderate.
The concern is the linear treatment of stakes, which needs a non-linear treatment.
The motivations behind the Prospect Theory are discussed by tracing back to the violations of both M-EU and Dual-EU through Kahneman and Tversky's 1979 paper.
The integrated framework of prospect theory combines elements of M-EU and Dual-EU.
Probabilities are subjectively transformed into decision weights.
Small probabilities of gains are overweight compared to large probabilities of gains.
Losses are overweight compared to gains.
Utility is defined over wealth changes and is concave for gains.
Utility is defined over wealth changes and is convex for losses.
Utility for losses is steeper than utility for gains.
Utility curvature, loss aversion, and probability weighting influence risk preferences.
A typical utility function is described for illustrating gains and losses.
The impact of utility on worldwide risk-preference patterns is considered through an analysis across different countries, including the USA, China, Guatemala, Ethiopia, and Nicaragua.
The typical utility functions for different countries are reviewed to indicate whether preferences are related to utility.
Changes in pessimism for gains and sensitivity for gains are discussed and patterns of different countries are shown.
Changes in optimism for losses and sensitivity for losses are discussed.
The method of measuring PT parameters is reviewed.
Results require parametric assumptions and structural equation models.
Identification of parameters can be non-parametrically using multiple stages and careful design.
Drawbacks of these methods include their cumbersomeness and difficulty in incentivizing.
Outcome intervals with equal utility are considered. The method of deriving these is also discussed.
The standard outcome sequence and its advantages are explained.
Probability equivalents are obtained using known utilities.
The method to derive the probability equivalents from tasks are given, with respect to gains and losses.
Violations of Stochastic Dominance are explained along with different outcomes.
The discussion highlights violations of stochastic dominance and the use of 'good news probabilities'.
Rank dependence is examined, which is a crucial element of modern Prospect Theory.
The method of transforming this aspect for gains and losses is considered.
Revisiting of paradoxes is considered in relationship with the commonly seen effects on framing, the common ratio effect, common consequence effect, lottery and insurance play, and the equity premium puzzle.
The presentation touches on the standard model of time discounting.
Samuelson's work on discounted utility is considered.
The standard model of time discounting and its relationship to absolute differences in time are outlined, as well as the implications.
The topic in the presentation on paradoxes for risk and time are reviewed.
The ambiguity aversion and the Ellsberg paradox are reviewed.
Prospect theory is used to account for ambiguity, using sources of preferences.
People's willingness to bet depends on their expertise and confidence relating to different sources of uncertainty.
Weighting functions are directly considered with respect to confidence and willingness.

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Description

Test your knowledge on the common ratio effect and its implications in behavioral economics. This quiz covers theories explaining the effect, aspects of traditional expected utility theory, and specific countries' sensitivities towards gains. Challenge yourself with questions related to probability transformations and the critiques of established theories.