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Description: In this video, Prof. Schilbach describes how economics looks at risk preferences, that is, choices involving risk. Specifically, he covers the topics of risk aversion, expected utility, absurd implications, and small- vs. large-scale risk aversion.
Jan 1, 2023 · Economist Frank H. Knight (1885–1972) is commonly credited with defining the distinction between decisions under “risk” (known chance) and decisions under “uncertainty” (unmeasurable probability) in his 1921 book Risk, Uncertainty and Profit. A closer reading of Knight (1921) reveals a host of psychological insights beyond this risk ...
- St. Petersburg Paradox
- Solution to The Paradox
- Daniel Bernoulli.
- Expected Utility and Risk Attitudes
Expected utility theory of decision making under risk dates back to the formulation of D. Bernoulli, an eighteenth century mathematician. He proposed the application of expected utility to solve the St. Petersburg paradox introduced by his uncle, N. Bernoulli. This paradox can be described as follows (Tamura et al., 1997). A coin with the probabili...
Bernoulli considered the following expected utility, EU, which is the expected value of the utility of logarithmic function u(2n) = log(2n). He demonstrated that the expected utility in this example would converge to a rather low finite value, i.e., log4 (approximately 1.4) which is worth utility of $4. However, in seeking the inverse function of t...
Born in 1700; deceased in 1782. He is well known by his work on the applications of mathematics to mechanics and the work in probability and statistics. Bernoulli also provided a solution to the St. Petersburg paradox as the basis of the expected utility theory. His theory describes that decision makers do not always maximize their expected value o...
1.3.1 Logarithmic Utility Function and Risk Avoidance
The utility function expressed by the logarithmic function shown in Fig. 1, Chap. 5 shows the property of “diminishing marginal utility,” which states that the larger the amount of money involved, the lesser the rate of utility increase that can be expected. In addition, this function means risk aversive decision-making. In risk aversive decision-making, even for options with the same expected value, reliable options are strongly preferred to risky options. For example, suppose there are two...
1.3.2 Risk Attitudes
Risk attitudes can be defined by expected utility for gambling when the results are stochastically generated. Specifically, in comparing options that produce reliable results (options without risk) with those that produce stochastic results (options with risk), when the expected utility of a risk-free option is equal to that of a risky option, then such an option is said to be risk neutral. Furthermore, when the expected utility of a risk-free option is higher than that of a risky option, thi...
- Kazuhisa Takemura
- 2014
Some behaviors observed in economics, like the disposition effect or the reversing of risk aversion/risk seeking in case of gains or losses (termed the reflection effect), can also be explained by referring to the prospect theory.
Lecture 8: Risk Preferences II. Description: This lecture continues the discussion of risk preferences, and delves into reference-dependent preferences, an alternative model to expected utility. Instructor: Prof. Frank Schilbach.
Apr 25, 2014 · In this review, I critically examine four of the most influential theories of decision-making from economics, psychology, and biology: expected utility theory, prospect theory, risk-sensitivity theory, and heuristic approaches.
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May 14, 2018 · Economists employ mathematics and logic to make this conviction concrete. Addressing these issues, the Handbook of the Economics of Risk and Uncertainty consists of two masterfully crafted prefaces and 14 chapters written by leading economists in theory, empirical, and experimental economics.
