Decision Making And The Prospect Theory

Most of us have to make decisions from the time we wake up until the time we go to bed at night. Answering questions like what should I eat for breakfast, can I make that yellow light and should I go to the gym or go out for pizza all require us to make a choice or a decision (Robbins, S.P., Judge, T.A., 2009). At work I am challenged with collaborating with managers and other leaders to make decisions based on scenarios and events that occur in the hospital.

Kahneman’s article is an analysis of intuitive thinking and how it guides our decision-making. Although primarily aimed at the field of psychology, it is an interdisciplinary article with applications in economic theorising. Kahneman attempts to differentiate between two systems of thought, one of intuition (system 1) and one of reasoning (system 2), and argues that many judgements and choices are made intuitively, rather than with reason (a slower and more deliberate process). Intuitive decision making, which encompasses heuristics, although generally more efficient and rapid, makes the agent potentially subject to errors due to framing effects or violations of dominance. The analysis of the studies and theoretical situations also provides criticism of the commonly held model of the rational agent within economics. The article also further conceptualises Kahneman’s theory, the Prospect Theory (Kahneman & Tversky, 1979), which has descriptive applications of people’s choice in decision-making situations involving risk and known probability of outcomes. These situations are typically unexplained by the more normative rational agent model.

Most decisions are made with analysis, but some are judgment calls not susceptible to analysis due to time or information constraints. Please write about a judgment call you’ve made recently that couldn’t be analyzed. It can be a big or small one, but should focus on a business issue. What was the situation, the alternatives you considered and evaluated, and your decision making process? Be sure to explain why you chose the alternative you did relative to others considered.

Investing behavior should be driven by information, analysis, and self-discipline, not by emotion or ‘hunch.’

This paper will cover two criminological theories and they will be applied to two types of criminality. The two theories chosen for the paper were developmental theory and rational choice theory. The two types of crimes that were chosen were organized crime, specifically focusing on gangs, and terrorism. Then the crimes will be compared and contrasted. Finally, the developmental theory will be applied to organized crime to explain why and how it happens. The rational choice theory will be applied to terrorism to explain what compels individuals to attempt this form of criminality.

Harry Markowitz 1991, developed a theory of “Portfolio choice”, that allows the investors to examine the risk as per the expected returns. In modern World, this theory is known as Modern portfolio theory (MPT). It attempts to attain the best portfolio expected return for a predefined portfolio risk, or to minimise the risk for the predefined expected returns, by a careful choice of assets. Though it’s a widely used theory, still has been challenged widely. The critics question the feasibility of theory as a strategy for

1. The four-step model for decision-making; See, Judge, Act, and Evaluate, applies onto the storyline by providing more insightfulness and reflection onto the decisions each character performs. In such cases, Sam uses this method by somewhat agreeing to let his daughter, Lucy, go into the foster care system. This was shown when he later confides and agrees to see Lucy on a limited amount of times each month. Even though at first, he was upset and furious having his only daughter taken away from him, he slowly managed to admit to this term when he recognized Lucy's happiness and safety.

In today’s economy, decision-making skills vary for each household; however, the bottom-line goal for every individual is to get the most for their money. In order to do this, there are 4 principles of individual decision-making: facing trade-offs, evaluating what one is giving up to obtain their goal, thinking at the margin, and responding to incentives.

Challenges are presented to people on the daily basis. What to eat, drink, where they have to go, who they need to see, and etc... These things all impact the decision making process and the decisions made. In financial decision making, highly successful people do not make investment decisions based on past sunk outcomes, rather by examining choices with no regard for past experiences; this approach conflicts with what one may expect. In addition to past experiences, there are several cognitive biases that influence decision making.

With attention to the previous information given, the principle of risk-return tradeoff is based on the thought that individuals are opposed to taking risk, meaning individuals would prefer to get a certain return on their investment rather than risking and getting an uncertain return. (Titman, Keown, & Martin, 2014) This principle tells us that investors will receive higher returns for taking on a bigger risk however; a challenge often seen in investors is how to calculate the tradeoff between risks and return with riskier investments. A higher expected rate of return is not always a higher actual return.

Loss aversion is the tendency for people to fear loss. The authors explain that this fear of loss can lead to unpredictable and often ruinous actions. It is shown that as the potential for loss increases, the stronger this force becomes. For example, many individuals encounter loss aversion when buying and selling stocks. During the Great Recession in the late 2000s, many stockholders experienced their stocks drastically drop in value. They feared if they sold their stocks, it would result in a tremendous loss of money. This fear of loss influenced many stockholders to hold on to their stocks hoping for them to rise back to their original value. Many stocks never increased in value after this incident. As a result, countless stockholders lost an immense amount of money. Loss aversion is an extremely strong force, however, it can be minimized by focusing on the big picture rather than short term consequences. If these stockholders had looked at the big picture and focused on studying the true value of each stock, they would have been able to minimize the amount of loss they would have to suffer.

The rational decision-making model describes a series of steps that decision makers should consider if their goal is to maximize the quality of their outcome. In other words, if you want to make sure that you make the best choice, going through the formal steps of the rational decision-making model may make sense. The following are the steps taken to come to a rational decision: 1. Identify the problem, 2. Establish decision criteria, 3. Weigh decision criteria, 4. Generate alternatives, 5. Evaluate the alternative, 6. Choose the best alternative, 7. Implement the decision, 8. Evaluate the decision.

Prospect theory is an important alternative descriptive theory for decision-making under unreliable situation (Kahneman and Tversky 1979), which includes real life selection and psychological analysis between choices that involve risk. Prospect theory, which efforts to explain individual make decisions between risky replacements based on the value of potential gains and losses (Wakker 2010), advanced from expected utility theory, which explains that investors want to maximize expected utility of wealth when unclearly situations (Blavatskyy 2007). According to Kahneman and Tversky (1992), more recent researches perceived nonlinear preferences in choices that do not involve definite events in prospective theory. The concept of framing effect refers description invariances (Kahneman and Tversky 1992). To be specific, individual always makes the same decision in identical choice conditions. Also, decision makers have tendency to

Applying the utility theory seems a rational choice as it can reflect the decision maker’s attitude toward risk. Still problems arise when the decision is made by more than one person. Based on their experiences within General Motors, Michael W. Kusnic and Daniel Owen have found that when there were more than one decision makers, it was less

In their research study, Souder & Myles (2010) identify that risk is chiefly fundamental to investing. Böhringer & Löschel (2008) further add that there is no discussion of returns or performance that is deemed meaningful in the absence of at least some mention of the involved risk. However, the trouble for investors, who have just entered into the marketplace, involves the process of figuring where risk really lies, as well as what the difference between the various levels of risks. Relating to the manner, in which risk is fundamental to investments, a significant number of new