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## What is wrong with expected utility theory?

Expected utility theory **makes faulty predictions about people’s decisions in many real-life choice situations** (see Kahneman & Tversky 1982); however, this does not settle whether people should make decisions on the basis of expected utility considerations.

## What does the Ellsberg paradox violate?

Ellsberg’s findings violate **assumptions made within common Expected Utility Theory**, with participants strictly preferring Gamble A to Gamble B and Gamble D to Gamble C.

## What are the assumptions of expected utility theory?

There are four axioms of the expected utility theory that define a rational decision maker: **completeness; transitivity; independence of irrelevant alternatives; and continuity**. Completeness assumes that an individual has well defined preferences and can always decide between any two alternatives. or both.

## Can prospect theory explain the Ellsberg paradox?

Next, a behavioral model based on our “Prospect Theory under Uncertainty” is described where basic probability of a set of events is known but occurrence probability of each event is not known. **It is shown that this model could properly explain the Ellsberg paradox of ambiguity aversion**.

## What is an expected utility Maximiser?

An expected utility maximiser is **a theoretical agent who considers its actions, computes their consequences and then rates them according to a utility function**. Next, it performs the action which it thinks is likely to produce the largest utility.

## What does expected utility theory say?

The expected utility of an entity is derived from the expected utility hypothesis. This hypothesis states that **under uncertainty, the weighted average of all possible levels of utility will best represent the utility at any given point in time**.

## What are the predictions of subjective expected utility theory?

According to the subjective expected utility theory, **individuals are more likely to select an option that maximize (minimize) the positive (negative) outcomes of their response** (Shanteau & Pingenot, 2009) .

## What is financial prospect theory?

The prospect theory says that **investors value gains and losses differently, placing more weight on perceived gains versus perceived losses**. An investor presented with a choice, both equal, will choose the one presented in terms of potential gains.

## Is a paradox true?

A paradox is a logically self-contradictory statement or a statement that runs contrary to one’s expectation. It is a statement that, despite apparently valid reasoning from true premises, leads to a seemingly self-contradictory or a logically unacceptable conclusion.

## What is loss aversion in psychology?

Loss aversion in behavioral economics refers to **a phenomenon where a real or potential loss is perceived by individuals as psychologically or emotionally more severe than an equivalent gain**. For instance, the pain of losing $100 is often far greater than the joy gained in finding the same amount.

## What is independence axiom?

The independence axiom **postulates that decision maker’s preferences between two lotteries are not affected by mixing both lotteries with the same third lottery** (in identical proportions).

## What is invariance axiom?

In addition to conventional smoothness and proportionality conditions, in each case an Invariance Axiom is proposed. For technological change this says, in a sense, that **when there is no technological change there is no change in the index**.

## What is independence in expected utility theory?

The independence axiom states that this **indifference should be independent of context**. That is if you put A and B inside another lottery you are still indifferent.

## Which of the following axioms does the Allais paradox violate?

Abstract. The so-called Allais Paradox (Allais (1953)) has been interpreted as a violation of the **independence axiom of Savage** (1954). Considering the standard experiments performed this inference is questionable. Rather the paradoxical behavior represents evidence against the expected utility hypothesis as a whole.

## How does prospect theory explain the Allais Paradox?

Prospect Theory: A form of decision theory that suggests people perceive value in relation to gains and losses rather than in absolute terms. Derived from experimental results, **it assumes that the prospect of a loss looms larger than that of a gain**.

## What is common consequence effect?

A common consequence effect (CCE) **occurs if the preference between two lotteries changes if the same probability mass is shifted from one common outcome to a different common outcome in both lotteries**.