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A problem for y'all

Discussion in 'Investing Strategies' started by Mark Laszczuk, 16th Jan, 2006.

  1. Mark Laszczuk

    Mark Laszczuk Well-Known Member

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    Alright, here are two problems for y'all to think about. Post answers to both and I'll post the solution in a few days.

    1. Prospect theory

    Kahneman and Tversky presented groups of subjects with a number of problems. One group of subjects was presented with this problem.

    1. In addition to whatever you own, you have been given $1,000. You are now asked to choose between:
    A. A sure gain of $500
    B. A 50% change to gain $1,000 and a 50% chance to gain nothing.

    Another group of subjects was presented with another problem.

    2. In addition to whatever you own, you have been given $2,000. You are now asked to choose between:
    A. A sure loss of $500
    B. A 50% chance to lose $1,000 and a 50% chance to lose nothing.

    Mark
     
  2. Sean

    Sean Member

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    Ok i'll be first sucker.... :eek:

    From what I can see the best and worst outcomes of 1a and 2a are identical and also for 2a and 2b. That being,

    1a and 2a - Best outcome is $1500.00. Worst outcome is $1500.00.

    2a and 2b - Best outcome is $2000.00. Worst outcome is $1000.00.

    So, based on that 2a and 2b are a risk of $500.00 for a possible gain of $500.00.
     
  3. MichaelWhyte

    MichaelWhyte Well-Known Member

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    Hmmm...

    Aren't they exactly the same.

    i.e. In each one, if you choose option A you end up with $1,500. This is the risk nothing option, the "sure thing". If you choose option B then you have a 50/50 chance of ending up with either $1,000 or $2,000 depending on the toss of the coin. These outcomes are $500 either side of the sure thing position of $1,500 so whether you "play" or not is not dependent on any statistical bias for or against you.

    Cheers,
    Michael.
     
  4. Mark Laszczuk

    Mark Laszczuk Well-Known Member

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    No no, maybe people are misunderstanding. What you're supposed to do is choose either a. or b. in both scenarios.

    Mark
     
  5. MichaelWhyte

    MichaelWhyte Well-Known Member

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    Mark,

    OK then, I'll take A in both scenarios thanks.

    Cheers,
    Michael.
     
  6. luckyone

    luckyone Member

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    I'll take B in both scenarios, I like a bit of risk!
     
  7. MichaelWhyte

    MichaelWhyte Well-Known Member

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    I only like risk when it is commensurate with the returns. I don't necessarily like risk for the sake of risk. Show me a risk where I have a fairly good chance of getting a positive return though, and I'll be in and in big!

    This example was 50/50 each way so I'll just take the bird in the hand and look for something with a weighting in my favour.

    Cheers,
    Michael.
     
  8. Simon

    Simon Well-Known Member

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    I think the purpose of the above experiment was to show that, although the same deal, people are more risk averse when it comes to a possible loss rather than a gain. So to express the identical situation as a loss should become a less popular choice - something along those lines I think.

    Was this correct Mark?
     
  9. Mark Laszczuk

    Mark Laszczuk Well-Known Member

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    Simon,

    I have the link at home, once I can get my connection working again, I'll post it up.

    Mark