Prospect Theory Quiz

Play an AI-generated podcast conversation about this lesson

What does the coefficient λ in the Prospect Theory value function represent?

Diminishing marginal sensitivity for gains

Risk seeking behavior

Coefficient of loss aversion (correct)

Reference point

Which aspect does Prospect Theory address that is not covered by Expected Utility Theory?

Linear decision weights

Risk aversion under certainty

Marginal utility of wealth

Impact of reference points (correct)

In the Prospect Theory value function, what happens to the sensitivity of losses as they increase?

Sensitivity increases logarithmically

Sensitivity increases sharply

Sensitivity decreases (correct)

Sensitivity remains constant

What is the value of α in the Prospect Theory value function related to?

Diminishing marginal sensitivity for gains Signup and view all the answers

What is indicated by a λ value of 2.25 in Prospect Theory?

High loss aversion Signup and view all the answers

What does Prospect Theory's editing phase involve?

Revising potential outcomes before evaluation Signup and view all the answers

How does Prospect Theory differ from Expected Utility Theory regarding outcomes?

It defines outcomes as gains and losses relative to a reference point Signup and view all the answers

What is a common anomaly in Expected Utility Theory as identified in Prospect Theory?

The independence axiom Signup and view all the answers

What role does loss aversion play in Prospect Theory?

It indicates that losses are valued significantly less than gains Signup and view all the answers

Which aspect of decision-making does Prospect Theory primarily address?

Emotional factors influencing financial decisions Signup and view all the answers

What does prospect theory primarily explain in decision making?

Loss aversion and risk seeking behavior Signup and view all the answers

In the context of decision weighting, what does the curvature γ (gamma) of the weighting function represent?

The shape of the probability weighting curve Signup and view all the answers

How is the probability weighting function characterized in prospect theory?

Inverted S-shaped curve Signup and view all the answers

What effect does loss aversion have on decision-making according to behavioral economics?

It leads individuals to prefer certain outcomes over gambles. Signup and view all the answers

What is meant by 'nonlinear preferences' in the context of prospect theory?

Utility changes at a different rate depending on the level of wealth. Signup and view all the answers

What does loss aversion refer to in behavioral economics?

The psychology behind increased dissatisfaction with potential losses compared to equivalent gains. Signup and view all the answers

In the context of nonlinear preferences, what does overweighting of small probabilities imply?

People evaluate small probabilities as having more significance than larger probabilities. Signup and view all the answers

What is a key characteristic of nonlinear preferences in decision-making?

Individuals' responses to probabilities often deviate from expected utility theory. Signup and view all the answers

What impact does the example of Russian roulette illustrate in behavioral economics?

The perceived reduction of risk is greater when decreasing the count of bullets is involved. Signup and view all the answers

Which of the following concepts is NOT associated with nonlinear preferences?

Consistent linear utility Signup and view all the answers

What characteristic does loss aversion represent in decision making under risk?

Stronger negative feelings towards losses than positive feelings towards gains Signup and view all the answers

Which of the following accurately defines a prospect in decision-making under risk?

A choice with multiple outcomes, each associated with a specific probability Signup and view all the answers

What is the formal representation of a prospect as described?

q = (x1, p1; x2, p2; ...; xn, pn) Signup and view all the answers

Which statement best describes risk-seeking behavior in decision making?

Opting for outcomes with greater variance regardless of expected utility Signup and view all the answers

Which of the following does NOT describe the anomalies in Expected Utility Theory (EUT)?

Rational decision-making that aligns perfectly with expected utility Signup and view all the answers

What does the Prospect Theory by Kahneman & Tversky emphasize in behavioral economics?

Subjective valuation of potential gains and losses Signup and view all the answers

In the presented example, which prospect offers a certainty equivalent?

Prospect B: Certainty of winning 45 Signup and view all the answers

Which aspect of decision making under risk is NOT a focus of Expected Utility Theory?

Loss aversion and risk-seeking behavior Signup and view all the answers

What does Prospect Theory incorporate that contrasts with Expected Utility Theory?

Nonlinear preferences Signup and view all the answers

Which of the following best defines loss aversion in the context of behavioral economics?

The principle that losses weigh heavier than equivalent gains Signup and view all the answers

In the context of evaluation under Prospect Theory, what are the two main stages described?

Editing and evaluation Signup and view all the answers

If V(A) is calculated as 2.55 for a set of outcomes, what does this value imply?

It is an expression of the expected utility of choice A Signup and view all the answers

What distinguishes risk-seeking behavior according to Prospect Theory?

Opting for higher potential losses over certain losses Signup and view all the answers

What does the equation E(q) = P(x_i)u(x_i) signify in Expected Utility Theory?

Utility maximization under risk conditions Signup and view all the answers

Which of the following outcomes represents a move towards risk aversion?

Preferring a certain outcome of $20 to a 50% chance of $50 Signup and view all the answers

What does the nonlinear aspect of preferences in behavioral economics suggest?

Individuals evaluate potential outcomes in a variable manner Signup and view all the answers