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36856 results in Cambridge Textbooks

Page 1746 of 1843

  • 10 - A Test of the Theory of Reference-Dependent Preferences

  • from PART THREE - LOSS AVERSION AND THE VALUE FUNCTION
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 180-201

  • Summary

    ABSTRACT. Eight alternative methods of eliciting preferences between money and a consumption good are identified: two of these are standard willingness-to-accept and willingness-to-pay measures. These methods differ with respect to the reference point used and the dimension in which responses are expressed. The loss aversion hypothesis of Tversky and Kahneman's theory of reference-dependent preferences predicts systematic differences between the preferences elicited by these methods. These predictions are tested by eliciting individuals' preferences for two private consumption goods; the experimental design is incentive-compatible and controls for income and substitution effects. The theory's predictions are broadly confirmed.

    In conventional consumer theory each individual's choices are determined by a preference ordering over consumption bundles; this ordering is independent of the individual's endowment. However, a number of recent papers have suggested that preferences may be conditioned on current endowments, and that individuals are typically “loss averse”: for example, a person may prefer bundle x to bundle y if she is endowed with x, but prefer y to x if endowed with y. The most fully worked-out general theory of this kind is probably Tversky and Kahneman's [1991] theory of reference-dependent preferences. Tversky and Kahneman present their theory as an explanation of a body of preexisting evidence. In this paper we report a systematic experimental test of some of the implications of reference-dependent theory.

  • 38 - Evaluation by Moments: Past and Future

  • from PART NINE - EXPERIENCED UTILITY AND OBJECTIVE HAPPINESS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 693-708

  • Summary

    We often have the occasion to evaluate the pleasantness or awfulness of incidents in people's lives; most of us have opinions about what it is like to be old, or physically handicapped, or a resident of California. All of us spontaneously score events and situations and store evaluations of how good or bad they were, in the form of likes and dislikes. These judgments and feelings have also been produced in the laboratory, with the usual combination of artificiality and improved precision.

    The goal of this chapter is to review the evidence for a unifying principle, which accounts for four conclusions of research on evaluations of outcomes. The first of these conclusions has been supported in many studies of choice.

  • The carriers of value in both risky and riskless choices are gains and losses. The same final state of wealth or endowment is valued differently, depending on its relation to the original state from which it has been reached (Kahneman and Tversky 1979). In studies of the endowment effect, for example, the outcomes of owning or not owning a particular decorated mug are represented, depending on the current reference point, as getting a mug or giving up a mug (Kahneman, Knetsch, and Thaler 1991; Thaler 1980; Tverksy and Kahneman 1991).

  • 27 - The Construction of Preference

  • from PART SIX - THE MULTIPLICITY OF VALUE: REVERSALS OF PREFERENCE
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 489-502

  • Summary

    ABSTRACT. One of the main themes that has emerged from behavioral decision research during the past 2 decades is the view that people's preferences are often constructed in the process of elicitation. This concept is derived in part from studies demonstrating that normatively equivalent methods of elicitation often give rise to systematically different responses. These “preference reversals” violate the principle of procedure invariance that is fundamental to theories of rational choice and raise difficult questions about the nature of human values. If different elicitation procedures produce different orderings of options, how can preferences be defined and in what sense do they exist? Describing and explaining such failures of invariance will require choice models of far greater complexity than the traditional models.

    The meaning of preference and the status of value may be illuminated by this well-known exchange among three baseball umpires. “I call them as I see them,” said the first. “I call them as they are,” claimed the second. The third disagreed, “They ain't nothing till I call them.” Analogously, we can describe three different views regarding the nature of values. First, values exist - like body temperature - and people perceive and report them as best they can, possibly with bias (“I call them as I see them”). Second, people know their values and preferences directly - as they know the multiplication table (“I call them as they are”). Third, values or preferences are commonly constructed in the process of elicitation (“They ain't nothing till I call them”). The research reviewed in this article is most compatible with the third view of preference as a constructive, context-dependent process.

    (Tversky & Thaler, 1990, p. 210)

  • 37 - Experienced Utility and Objective Happiness: A Moment-Based Approach

  • from PART NINE - EXPERIENCED UTILITY AND OBJECTIVE HAPPINESS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 673-692

  • Summary

    INTRODUCTION

    The concept of utility has carried two different meanings in its long history. As Bentham (1789) used it, utility refers to the experiences of pleasure and pain, the “sovereign masters” that “point out what we ought to do, as well as determine what we shall do.” In modern decision research, however, the utility of outcomes refers to their weight in decisions: utility is inferred from observed choices and is in turn used to explain choices. To distinguish the two notions I refer to Bentham's concept as experienced utility and to the modern usage as decision utility. Experienced utility is the focus of this chapter. Contrary to the behaviorist position that led to the abandonment of Bentham's notion (Loewenstein 1992), the claim made here is that experienced utility can be usefully measured.

    The chapter has three main goals: (1) to present a detailed analysis of the concept of experienced utility and of the relation between the pleasure and pain of moments and the utility of more extended episodes; (2) to argue that experienced utility is best measured by moment-based methods that assess current experience; (3) to develop a moment-based conception of an aspect of well-being that I will call “objective happiness.” The chapter also introduces several unfamiliar concepts that will be used in later chapters.

    Pleasure and pain are attributes of a moment of experience, but the outcomes that people value extend over time. It is therefore necessary to establish a concept of experienced utility that applies to temporally extended outcomes. Two approaches to this task will be compared here.

  • 15 - Toward a Positive Theory of Consumer Choice

  • from PART FIVE - APPLICATIONS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 269-287

  • Summary

    ABSTRACT. The economic theory of the consumer is a combination of positive and normative theories. Since it is based on a rational maximizing model it describes how consumers should choose, but it is alleged to also describe how they do choose. This paper argues that in certain well-defined situations many consumers act in a manner that is inconsistent with economic theory. In these situations economic theory will make systematic errors in predicting behavior. Kahneman and Tversky's prospect theory is proposed as the basis for an alternative descriptive theory. Topics discussed are under-weighting of opportunity costs, failure to ignore sunk costs, search behavior, choosing not to choose and regret, and precommitment and self-control.

    INTRODUCTION

    Economists rarely draw the distinction between normative models of consumer choice and descriptive or positive models. Although the theory is normatively based (it describes what rational consumers should do), economists argue that it also serves well as a descriptive theory (it predicts what consumers in fact do). This paper argues that exclusive reliance on the normative theory leads economists to make systematic, predictable errors in describing or forecasting consumer choices.

    In some situations the normative and positive theories coincide. If a consumer must add two (small) numbers together as part of a decision process, then one would hope that the normative answer would be a good predictor. So if a problem is sufficiently simple the normative theory will be acceptable. Furthermore, the sign of the substitution effect, the most important prediction in economics, has been shown to be negative even if consumers choose at random (Becker, 1962).

  • 7 - Loss Aversion in Riskless Choice: A Reference-Dependent Model

  • from PART THREE - LOSS AVERSION AND THE VALUE FUNCTION
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 143-158

  • Summary

    ABSTRACT. Much experimental evidence indicates that choice depends on the status quo or reference level: changes of reference point often lead to reversals of preference. We present a reference-dependent theory of consumer choice, which explains such effects by a deformation of indifference curves about the reference point. The central assumption of the theory is that losses and disadvantages have greater impact on preferences than gains and advantages. Implications of loss aversion for economic behavior are considered.

    The standard models of decision making assume that preferences do not depend on current assets. This assumption greatly simplifies the analysis of individual choice and the prediction of trades: indifference curves are drawn without reference to current holdings, and the Coase theorem asserts that, except for transaction costs, initial entitlements do not affect final allocations. The facts of the matter are more complex. There is substantial evidence that initial entitlements do matter and that the rate of exchange between goods can be quite different depending on which is acquired and which is given up, even in the absence of transaction costs or income effects. In accord with a psychological analysis of value, reference levels play a large role in determining preferences. In the present paper we review the evidence for this proposition and offer a theory that generalizes the standard model by introducing a reference state.

  • 3 - Advances in Prospect Theory: Cumulative Representation of Uncertainty

  • from PART ONE - PROSPECT THEORY AND EXTENSIONS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 44-66

  • Summary

    ABSTRACT. We develop a new version of prospect theory that employs cumulative rather than separable decision weights and extends the theory in several respects. This version, called cumulative prospect theory, applies to uncertain as well as to risky prospects with any number of outcomes, and it allows different weighting functions for gains and for losses. Two principles, diminishing sensitivity and loss aversion, are invoked to explain the characteristic curvature of the value function and the weighting functions. A review of the experimental evidence and the results of a new experiment confirm a distinctive fourfold pattern of risk attitudes: risk aversion for gains and risk seeking for losses of high probability; risk seeking for gains and risk aversion for losses of low probability.

    KEYWORDS cumulative prospect theory

    Expected utility theory reigned for several decades as the dominant normative and descriptive model of decision making under uncertainty, but it has come under serious question in recent years. There is now general agreement that the theory does not provide an adequate description of individual choice: a substantial body of evidence shows that decision makers systematically violate its basic tenets. Many alternative models have been proposed in response to this empirical challenge (for reviews, see Camerer, 1989; Fishburn, 1988; Machina, 1987).

  • 21 - Are Investors Reluctant to Realize Their Losses?

  • from PART FIVE - APPLICATIONS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 371-392

  • Summary

    ABSTRACT. I test the disposition effect, the tendency of investors to hold losing investments too long and sell winning investments too soon, by analyzing trading records for 10,000 accounts at a large discount brokerage house. These investors demonstrate a strong preference for realizing winners rather than losers. Their behavior does not appear to be motivated by a desire to rebalance portfolios, or to avoid the higher trading costs of low priced stocks. Nor is it justified by subsequent portfolio performance. For taxable investments, it is suboptimal and leads to lower after-tax returns. Tax-motivated selling is most evident in December.

    The tendency to hold losers too long and sell winners too soon has been labeled the disposition effect by Shefrin and Statman (1985). For taxable investments the disposition effect predicts that people will behave quite differently than they would if they paid attention to tax consequences. To test the disposition effect, I obtained the trading records from 1987 through 1993 for 10,000 accounts at a large discount brokerage house. An analysis of these records shows that, overall, investors realize their gains more readily than their losses. The analysis also indicates that many investors engage in taxmotivated selling, especially in December. Alternative explanations have been proposed for why investors might realize their profitable investments while retaining their losing investments.

  • 22 - Timid Choices and Bold Forecasts: A Cognitive Perspective on Risk Taking

  • from PART FIVE - APPLICATIONS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 393-413

  • Summary

    ABSTRACT. Decision makers have a strong tendency to consider problems as unique. They isolate the current choice from future opportunities and neglect the statistics of the past in evaluating current plans. Overly cautious attitudes to risk result from a failure to appreciate the effects of statistical aggregation in mitigating relative risk. Overly optimistic forecasts result from the adoption of an inside view of the problem, which anchors predictions on plans and scenarios. The conflicting biases are documented in psychological research. Possible implications for decision making in organizations are examined.

    KEY WORDS decision making; risk; forecasting; managerial cognition

    The thesis of this essay is that decision makers are excessively prone to treat problems as unique, neglecting both the statistics of the past and the multiple opportunities of the future. In part as a result, they are susceptible to two biases, which we label isolation errors: their forecasts of future outcomes are often anchored on plans and scenarios of success rather than on past results and are therefore overly optimistic; their evaluations of single risky prospects neglect the possibilities of pooling risks and are therefore overly timid. We argue that the balance of the two isolation errors affects the risk-taking propensities of individuals and organizations.

    The cognitive analysis of risk taking that we sketch differs from the standard rational model of economics and also from managers' views of their own activities. The rational model describes business decisions as choices among gambles with financial outcomes, and assumes that managers' judgments of the odds are Bayesian, and that their choices maximize expected utility.

  • 42 - New Challenges to the Rationality Assumption

  • from PART NINE - EXPERIENCED UTILITY AND OBJECTIVE HAPPINESS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 758-774

  • Summary

    ABSTRACT. In contrast to logical criteria of rationality, which can be assessed entirely by reference to the system of preferences, substantive criteria of rational choice refer to an independent evaluation of the outcomes of decisions. One of these substantive criteria is the experienced hedonic utility of outcomes. Research indicates that people are myopic in their decisions, may lack skill in predicting their future tastes, and can be led to erroneous choices by fallible memory and incorrect evaluation of past experiences. Theoretical and practical implications of these challenges to the assumption of economic rationality are discussed. (JEL: A 00)

    INTRODUCTION

    The assumption that agents are rational is central to much theory in the social sciences. Its role is particularly obvious in economic analysis, where it supports the useful corollary that no significant opportunity will remain unexploited. In the domain of social policy, the rationality assumption supports the position that it is unnecessary to protect people against the consequences of their choices. The status of this assumption is therefore a matter of considerable interest. This article will argue for an enriched definition of rationality that considers the actual outcomes of decisions, and will present evidence that challenges the rationality assumption in new ways.

    The criteria for using the terms “rational” or “irrational” in non-technical discourse are substantive: one asks whether beliefs are grossly out of kilter with available evidence, and whether decisions serve or damage the agent's interests.

  • 6 - A Belief-Based Account of Decision under Uncertainty

  • from PART TWO - THE UNCERTAINTY EFFECT AND THE WEIGHTING FUNCTION
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 118-142

  • Summary

    ABSTRACT. We develop a belief-based account of decision under uncertainty. This model predicts decisions under uncertainty from (i) judgments of probability, which are assumed to satisfy support theory; and (ii) decisions under risk, which are assumed to satisfy prospect theory. In two experiments, subjects evaluated uncertain prospects and assessed the probability of the respective events. Study 1 involved the 1995 professional basketball playoffs; Study 2 involved the movement of economic indicators in a simulated economy. The results of both studies are consistent with the belief-based account, but violate the partition inequality implied by the classical theory of decision under uncertainty.

    KEY WORDS decision making; risk; uncertainty; expected utility; prospect theory; support theory; decision weights; judgment; probability

    INTRODUCTION

    It seems obvious that the decisions to invest in the stock market, undergo a medical treatment, or settle out of court depend on the strength of people's beliefs that the market will go up, that the treatment will be successful, or that the court will decide in their favor. It is less obvious how to elicit and measure such beliefs. The classical theory of decision under uncertainty derives beliefs about the likelihood of uncertain events from people's choices between prospects whose consequences are contingent on these events. This approach, first advanced by Ramsey (1931), gives rise to an elegant axiomatic theory that yields simultaneous measurement of utility and subjective probability, thereby bypassing the thorny problem of how to interpret direct expressions of belief.

  • 39 - Endowments and Contrast in Judgments of Well-Being

  • from PART NINE - EXPERIENCED UTILITY AND OBJECTIVE HAPPINESS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 709-725

  • Summary

    In a recent educational television program, an amnesic patient was asked about his childhood and high-school experiences. Verbally fluent, he was able to converse about daily events but could not remember any details about his past. Finally, the interviewer asked him how happy he was. The patient pondered this question for a few seconds before answering, “I don't know.”

    As Tom Schelling observed, “We consume past events that we can bring up from memory” (1984, p. 344). Thus, the memory of the past is an essential element of present well-being. As our opening anecdote suggests, the present alone may not provide enough information to define happiness without reference to the past. Yet memories have a complex effect on our current sense of well-being. They represent a direct source of happiness or unhappiness, and they also affect the criteria by which current events are evaluated. In other words, a salient hedonic event (positive or negative) influences later evaluations of well-being in two ways: through an endowment effect and a contrast effect. The endowment effect of an event represents its direct contribution to one's happiness or satisfaction. Good news and positive experiences enrich our lives and make us happier; bad news and hard times diminish our well-being. Events also exercise an indirect contrast effect on the evaluation of subsequent events. A positive experience makes us happy, but it also renders similar experiences less exciting. A negative experience makes us unhappy, but it also helps us appreciate subsequent experiences that are less bad. The hedonic impact of an event, we suggest, reflects a balance of its endowment1 and contrast effects. This chapter explores some descriptive and prescriptive implications of this notion.

  • 16 - Prospect Theory in the Wild: Evidence from the Field

  • from PART FIVE - APPLICATIONS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 288-300

  • Summary

    The workhorses of economic analysis are simple formal models that can explain naturally occurring phenomena. Reflecting this taste, economists often say they will incorporate more psychological ideas into economics if those ideas can parsimoniously account for field data better than standard theories do. Taking this statement seriously, this article describes 10 regularities in naturally occurring data that are anomalies for expected utility theory but can all be explained by three simple elements of prospect theory: loss aversion, reflection effects, and nonlinear weighting of probability; moreover, the assumption is made that people isolate decisions (or edit them) from others they might be grouped with (Read, Loewenstein, and Rabin 1999; cf. Thaler, 1999). I hope to show how much success has already been had applying prospect theory to field data and to inspire economists and psychologists to spend more time in the wild.

    The 10 patterns are summarized in Table 16.1. To keep the article brief, I sketch expected utility and prospect theory very quickly. (Readers who want to know more should look elsewhere in this volume or in Camerer 1995 or Rabin 1998a). In expected utility, gambles that yield risky outcomes xi with probabilities pi are valued according to Σpiu(xi), where u(x) is the utility of outcome x. In prospect theory they are valued by Σπ(pi)v(xi - r), where π(p) is a function that weights probabilities nonlinearly, overweighting probabilities below.

  • 2 - Prospect Theory: An Analysis of Decision under Risk

  • from PART ONE - PROSPECT THEORY AND EXTENSIONS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 17-43

  • Summary

    ABSTRACT. This paper presents a critique of expected utility theory as a descriptive model of decision making under risk and develops an alternative model, called prospect theory. Choices among risky prospects exhibit several pervasive effects that are inconsistent with the basic tenets of utility theory. In particular, people underweight outcomes that are merely probable in comparison with outcomes that are obtained with certainty. This tendency, called the certainty effect, contributes to risk aversion in choices involving sure gains and to risk seeking in choices involving sure losses. In addition, people generally discard components that are shared by all prospects under consideration. This tendency, called the isolation effect, leads to inconsistent preferences when the same choice is presented in different forms. An alternative theory of choice is developed, in which value is assigned to gains and losses rather than to final assets and in which probabilities are replaced by decision weights. The value function is normally concave for gains, commonly convex for losses, and is generally steeper for losses than for gains. Decision weights are generally lower than the corresponding probabilities, except in the range of low probabilities. Overweighting of low probabilities may contribute to the attractiveness of both insurance and gambling.

    INTRODUCTION

    Expected utility theory has dominated the analysis of decision making under risk. It has been generally accepted as a normative model of rational choice (Keeney & Raiffa, 1976), and widely applied as a descriptive model of economic behavior, e.g. (Friedman & Savage, 1948; Arrow, 1971). Thus, it is assumed that all reasonable people would wish to obey the axioms of the theory (von Neumann & Morgenstern, 1944; Savage, 1954), and that most people actually do, most of the time.

  • 8 - Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias

  • from PART THREE - LOSS AVERSION AND THE VALUE FUNCTION
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 159-170

  • Summary

    Economics can be distinguished from other social sciences by the belief that most (all?) behavior can be explained by assuming that agents have stable, well-defined preferences and make rational choices consistent with those preferences in markets that (eventually) clear. An empirical result qualifies as an anomaly if it is difficult to “rationalize,” or if implausible assumptions are necessary to explain it within the paradigm. This column presents a series of such anomalies. Readers are invited to suggest topics for future columns by sending a note with some reference to (or better yet copies of) the relevant research. Comments on anomalies printed here are also welcome. The address is Richard Thaler, c/o Journal of Economic Perspectives, Johnson Graduate School of Management, Malott Hall, Cornell University, Ithaca, NY 14853.

    After this issue, the “Anomalies” column will no longer appear in every issue and instead will appear occasionally, when a pressing anomaly crosses Dick Thaler's desk. However, suggestions for new columns and comments on old ones are still welcome. Thaler would like to quash one rumor before it gets started, namely that he is cutting back because he has run out of anomalies. Au contraire, it is the dilemma of choosing which juicy anomaly to discuss that takes so much time.

Page 1746 of 1843