A problem for y'all

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

1. Mark LaszczukWell-Known Member

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Location:
Brisbane
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. SeanMember

Joined:
23rd Aug, 2005
Posts:
24
Ok i'll be first sucker....

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. MichaelWhyteWell-Known Member

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5th Oct, 2005
Posts:
798
Location:
Sydney, NSW
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 LaszczukWell-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. MichaelWhyteWell-Known Member

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Mark,

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

Cheers,
Michael.

6. luckyoneMember

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Location:
Canberra, ACT
I'll take B in both scenarios, I like a bit of risk!

7. MichaelWhyteWell-Known Member

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Location:
Sydney, NSW
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. SimonWell-Known Member

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17th Sep, 2005
Posts:
520
Location:
Newcastle
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.

9. Mark LaszczukWell-Known Member

Joined:
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Posts:
793
Location:
Brisbane
Simon,

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

Mark