《投资学原理 Investments》课程教学资源（阅读资料）prospect theory-an analysis of decision under risk（k&t,1979）

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ECONOMETRICA Ⅴ OLUME47 MARCH 1979 NUMBER 2 PROSPECT THEORY: AN ANALYSIS OF DECISION UNDER RISK BY DANIEL KAHNEMAN AND AMOS TVERSKY jue of expected utility theory as a descriptive model of decision making under risk, and develops an alternative model, called prosp hoices among risky prospects exhibit several pervasive effects that are inconsistent with the basic tenets of utility theory. In particular, people underweight outcomes that are erely probable in comparison with outcomes that are obtained with certainty. This gains and to risk seeking in choices involving sure losses. In addition, people general discard components that are shared by all prospects under consideration. This tendency called the isolation effect, leads to inconsistent prefe presented in different forms. An alternative theory of choice is developed, in which valt assigned to gains and losses rather than to final assets and in which probabilities are eplaced by decision weights. The value function is normally concave for gains, commonly nvex for losses, and is generally steeper for losses than for gains. Decision weights are enerally lower than the corresponding probabilities, except in the range of low prob abilities. Overweighting of low probabilities may contribute to the attractiveness of both nsurance and gambling 1. IN EXPECTED UTILITY THEORY has dominated the analysis of decision making under risk. It has been generally accepted as a normative model of rational choice [24], and widely applied as a descriptive model of economic behavior, e. g. [15, 4 Thus, it is assumed that all reasonable people would wish to obey the axioms of the theory [47, 36], and that most people actually do, most of the time The present paper describes several classes of choice problems in which preferences systematically violate the axioms of expected utility theory. In the ight of these observations we argue that utility theory, as it is commonly terpreted and applied, is not an adequate descriptive model and we propose an alternative account of choice under risk Decision making under risk can be viewed as a choice between prospects or gambles. A prospect(x1, Pi;.;n, Pn)is a contract that yields outcome x; with probability Pi, where Pi+P2+.. +pn=1. To simplify notation, we omit null outcomes and use(x, p)to denote the prospect(x, p; 0, 1-p) that yields x with probability p and o with probability 1-p. The (riskless) prospect that yields with certainty is denoted by(x). The present discussion is restricted to prospects with so-called objective or standard probabilities The application of expected utility theory to choices between prospects is based three t Expectation: U(1, Pi;...;xn, pn)=pu(x1)+..+pnu(xn <A 'This work was supported in part by grants from the Harry F, Guggenheim Foundation and from Naval Research under Contract N00014-78-C-0100(ARPA Order No 3469)under Subcontract 78-072-0722 from Decisions and Designs, Inc. to Perceptronics, Inc. We also thank the Center for Advanced Study in the Behavioral Sciences at Stanford for its support

D. KAHNEMAN AND A. TVERSKY That is, the overall utility of a prospect, denoted by u, is the expected utility of outcomes sset Integration: (x1, Pi;...; xn, Pn )is acceptable at asset position w iff U(w+x1,p1; That is, a prospect is acceptable if the utility resulting from integrating the prospect with one's assets exceeds the utility of those assets alone. Thus, the domain of the utility function is final states (which include one's asset position) rather than gains or losses Although the domain of the utility function is not limited to any particular class of consequences, most applications of the theory have been concerned with monetary outcomes. Furthermore, most economic applications introduce the following additional assumption ( ii) Risk Aversion: u is concave(u<O A person is risk averse if he prefers the certain prospect(x)to any risky prospect with expected value x. In expected utility theory, risk aversion is equivalent to the concavity of the utility function. The prevalence of risk aversion is perhaps the best known generalization regarding risky choices. It led the early decision theorists of the eighteenth century to propose that utility is a concave function of money, and this idea has been retained in modern treatments( Pratt [33],Arrow In the following sections we demonstrate several phenomena which violate these tenets of expected utility theory. The demonstrations are based on the responses of students and university faculty to hypothetical choice problems. The respondents were presented with problems of the type illustrated below Which of the following would you prefer? A: 50% chance to win 1.000 B: 450 for sure 50% chance to win nothing The outcomes refer to Israeli currency. To appreciate the significance of the amounts involved, note that the median net monthly income for a family is about 3,000 Israeli pounds. The respondents were asked to imagine that they were actually faced with the choice described in the problem, and to indicate the decision they would have made in such a case. The responses were anonymous and the instructions specified that there was nocorrect'answer to such problems and that the aim of the study was to find out how people choose among risky prospects. The problems were presented in questionnaire form, with at most a dozen problems per booklet. Several forms of each questionnaire were con structed so that subjects were exposed to the problems in different orders. In addition, two versions of each problem were used in which the left-right position of the prospects was reversed The problems described in this paper are selected illustrations of a series of ffects. Every effect has been observed in several problems with different outcomes and probabilities. Some of the problems have also been presented to groups of students and faculty at the University of Stockholm and at the

PROSPECT THEORY 265 University of Michigan. The pattern of results was essentially identical to the results obtained from Israeli subjects. The reliance on hypothetical choices raises obvious questions regarding the validity of the method and the generalizability of the results. We are keenly aware of these problems. However, all other methods that have been used to test utility theory also suffer from severe drawbacks. Real choices can be investigated either in the field by naturalistic or statistical observations of economic behavior, or in the laboratory. Field studies can only provide for rather crude tests of qualitative predictions, because probabilities and utilities cannot be adequately measured in such contexts. Laboratory experiments have been designed to obtain precise measures of utility and probability from actual choices, but these experimental studies typically involve contrived gambles for small stakes, and a large number of repetitions of very similar problems. These features of laboratory gambling complicate the interpretation of the results and restrict their generality By default, the method of hypothetical choices emerges as the simplest pro cedure by which a large number of theoretical questions can be investigated the use of the method relies on the assumption that people often know how they ould behave in actual situations of choice, and on the further assumption that the subjects have no special reason to disguise their true preferences. If people are easonably accurate in predicting their choices, the presence of common and systematic violations of expected utility theory in hypothetical problems provides presumptive evidence against that theory Certainty, Probability, and Possibility In expected utility theory, the utilities of outcomes are weighted by their probabilities. The present section describes a series of choice problems in which eople's preferences systematically violate this principle. We first show that people overweight outcomes that are considered certain, relative to outcomes which are merely probable phenomenon which we label the certainty effect The best known counter-example to expected utility theory which exploits the certainty effect was introduced by the French economist Maurice Allais in 1953 [2. Allais'example has been discussed from both normative and descriptive standpoints by many authors [28, 38]. The following pair of choice problems is a variation of Allais' example, which differs from the original in that it refers to moderate rather than to extremely large gains. The number of respondents who answered each problem is denoted by N, and the percentage who choose each option is given in brackets PRObLEM 1: Choose between A 2, 500 with probability 33, B: 2, 400 with certainty 2, 400 with probability 66 O with probabilit [18]

KAHNEMAN AND A. TVERSKY ProblEM 2: Choose between C: 2, 500 with probability .33, D: 2, 400 with probability .34 0 with probability .67 0 with probability 66. [83]* The data show that 82 per cent of the subjects chose B in Problem 1, and 83 per cent of the subjects chose C in Problem 2. Each of these preferences is significant at the. 01 level, as denoted by the asterisk. Moreover, the analysis of individual patterns of choice indicates that a majority of respondents(61 per cent)made the modal choice in both problems. This pattern of preferences violates expected utility theory in the manner originally described by Allais. According to that leory, with u(0)=0, the first preference implies (2,400)>,33(2,500)+.66(2,400)or,34u(2,400)>,33(2,500) while the second preference implies the reverse inequality. Note that problem 2 is btained from Problem 1 by eliminating a 66 chance of winning 2400 from both prospects under consideration. Evidently, this change produces a greater reduc- tion in desirability when it alters the character of the prospect from a sure gain to a probable one, than when both the original and the reduced prospects are A simpler demonstration of the same phenomenon, involving only two- outcome gambles is given below. This example is also based on Allais [2 PROBLEM 3 A:(4,000,80), B:(3,000 N=95[20] [80J PROBLEM 4 C:(4,000,20),orD:(3,000,25) N=95[65] [35] In this pair of problems as well as in all other problem- pairs in this section, over half the respondents violated expected utility theory. To show that the modal pattern of preferences in Problems 3 and 4 is not compatible with the theory, set u(0)=0, and recall that the choice of B implies u(3, 000)/u(4, 000)>4/5 whereas the choice of C implies the reverse inequality. Note that the prospect C=(4,000,20)can be expressed as(A, 25), while the prospect D=(3, 000, 25) can be rewritten as(B,. 25). The substitution axiom of utility theory asserts that if B is preferred to A, then any (probability)mixture (B, p) must be preferred to the mixture(A, p). Our subjects did not obey this axiom. Apparently, reducing the probability of winning from 1.0 to, 25 has a greater effect than the reduction from

D. KAHNEMAN AND A. TVERSKY The Reflection Efect The previous section discussed preferences between positive prospects, i. e prospects that involve no losses. What happens when the signs of the outcomes are reversed so that gains are replaced by losses? The left-hand column of Table I displays four of the choice problems that were discussed in the previous sect and the right-hand column displays choice problems in which the signs of outcomes are reversed we use -x to denote the loss of x and to denote prevalent preference, 1. e, the choice made by the majority of subjects TABLE I PREFERENCES BETWEEN POSITIVE AND NEGATIVE PROSPECTS Positive prospects oblem3:(4,000,80)(3,000,25) Problem 4: ( (3,000,90)>(6,000,,45) 6,000,45) Problem8:(3,000,002)(-6,000,001) [27] [73 N=66 [70 In each of the four problems in Table I the preference between negative prospects is the mirror image of the preference between positive prospects. Thus the reflection of prospects around O reverses the preference order. We label this pattern the reflection effect Let us turn now to the implications of these data First, note that the reflection effect implies that risk aversion in the positive domain is accompanied by risk seeking in the negative domain, In Problem 3, for example, the majority of subjects were willing to accept a risk of 80 to lose 4,000, in preference to a sure loss of 3, 000, although the gamble has a lower expected value The occurrence of isk seeking in choices between negative prospects was noted early by Markowitz [29]. Williams [48] reported data where a translation of outcomes produces a dramatic shift from risk aversion to risk seeking. For example, his subjects wer indifferent between(100, 65;-100, 35)and(0), indicating risk aversion. They were also indifferent between(-200, 80)and (100), indicating risk seeking.A recent review by Fishburn and Kochenberger [14] documents the prevalence of risk seeking in choices between negative prospects Second, recall that the preferences between the positive prospects in Table I are inconsistent with expected utility theory. The preferences between the cor- responding negative prospects also violate the expectation principle in the same manner. For example, Problems 3 and 4, like Problems 3 and 4, demonstrate that outcomes which are obtained with certainty are overweighted relative to uncertain outcomes. In the positive domain, the certainty effect contributes to a risk averse preference for a sure gain over a larger gain that is merely probable.In the negative domain, the same effect leads to a risk seeking preference for a loss

PROSPECT THEORY 269 that is merely probable over a smaller loss that is certain. The same psychological principle-the overweighting of certainty--favors risk aversion in the domain of gains and risk seeking in the domain of losses Third the refection effect eliminates aversion for uncertainty or variability as in explanation of the certainty effect. Consider, for example, the prevalent preferences for (3, 000)over(4,000, 80)and for (4,000,. 20)over(3, 000,. 25). To resolve this apparent inconsistency one could invoke the assumption that people prefer prospects that have high expected value and small variance(see, e.g., Allais [2: Markowitz [30]; Tobin [41]). Since (3, 000) has no variance while(4,000,. 80) has large variance, the former prospect could be chosen despite its lower expected value. When the prospects are reduced however, the difference in variance between (3, 000, 25) and (4, 000, 20) may be insufficient to overcome the difference in expected value. Because(3, 000) has both higher expected value and lower variance than (4, 000, 80), this account entails that the sure loss should be preferred, contrary to the data. Thus, our data are incompatible with the notion that certainty is generally desirable. Rather, it appears that certainty increases the aversiveness of losses as well as the desirability of gains Probabilistic Insurance The prevalence of the purchase of insurance against both large and small losse as been regarded by many as strong evidence for the concavity of the utility function for money. Why otherwise would people spend so much money to purchase insurance policies at a price that exceeds the expected actuarial cost? However, an examination of the relative attractiveness of various forms of nsurance does not support the notion that the utility function for money is concave everywhere. For example, people often prefer insurance programs that offer limited coverage with low or zero deductible over comparable policies that offer higher maximal coverage with higher deductibles-contrary to risk aversion (see, e. g, Fuchs [16]. Another type of insurance problem in which people esponses are inconsistent with the concavity hypothesis may be called prob- abilistic insurance. To illustrate this concept, consider the following problem, which was presented to 95 Stanford University students PROBLEM 9: Suppose you consider the possibility of insuring some property against damage, e. g, fire or theft. After examining the risks and the premium you find that you have no clear preference between the options of purchasing insurance or leaving the property uninsured It is then called to your attention that the insurance company offers a new program called probabilistic insurance. In this program you pay half of the regular premium. In case of damage, there is a 50 per cent chance that you pay the other half of the premium and the insurance company covers all the losses; and there is a 50 per cent chance that you get back your insurance payment and suffer all the losses. For example, if an accident occurs on an odd day of the month, you pay the other half of the regular premium and your losses are covered; but if the accident

270 D, KAHNEMAN AND A. TVERSKY occurs on an even day of the month, your insurance payment is refunded and your losses are not covered Recall that the premium for full coverage is such that you find this insurance barely worth its cost. Under these circumstances, would you purchase probabilistic insurance Y N=9520][80]* Although Problem 9 may appear contrived, it is worth noting that probabilistic insurance represents many forms of protective action where one pays a certain cost to reduce the probability of an undesirable event-without eliminating it altogether. The installation of a burglar alarm, the replacement of old tires, and the decision to stop smoking can all be viewed as probabilistic insurance The responses to Problem 9 and to several other variants of the same question indicate that probabilistic insurance is generally unattractive. Apparently, reduc ing the probability of a loss from p to p/2 is less valuable than reducing the probability of that loss from p/2 to 0 In contrast to these data, expected utility theory(with a concave u)implies that probabilistic insurance is superior to regular insurance. That is, if at asset position w one is just willing to pay a premium y to insure against a probability p of losing x, then one should definitely be willing to pay a smaller premium ry to reduce the probability of losing x from p to(1-r)p, 01-por(w-ry)>1- which holds if and only if u is concave This is a rather puzzling consequence of the risk aversion hypothesis of utility theory, because probabilistic insurance appears intuitively riskier than regular insurance, which entirely eliminates the element of risk. Evidently, the intuitive notion of risk is not adequately captured by the assumed concavity of the utility function for wealth The aversion for probabilistic insurance is particularly intriguing because all insurance is, in a sense, probabilistic. The most avid buyer of insurance remains ulnerable to many financial and other risks which his policies do not cover. There appears to be a significant difference between probabilistic insurance and what may be called contingent insurance, which provides the certainty of coverage for a

PROSPECT THEORY 271 specified type of risk. Compare, for example, probabilistic insurance against all forms of loss or damage to the contents of your home and contingent insurance that eliminates all risk of loss from theft, say, but does not cover other risks, e. g fire. We conjecture that contingent insurance will be generally more attractive than probabilistic insurance when the probabilities of unprotected loss are equated. Thus, two prospects that are equivalent in probabilities and outcomes could have different values depending on their formulation. Several demon strations of this general phenomenon are described in the next section The Isolation effecr In order to simplify the choice between alternatives, people often disregard components that the alternatives share and focus on the components that distinguish them(Tversky [44]). This approach to choice problems may produce inconsistent preferences, because a pair of prospects can be decomposed into common and distinctive components in more than one way, and different decom positions sometimes lead to different preferences. We refer to this phenomenon the isolation effect PROBLEM 10: Consider the following two-stage game. In the first stage there probability of. 75 to end the game without winning anything, and a probability of 25 to move into the second stage. If you reach the second stage you have a choice tween (4,000,80)and(3,000) Your choice must be made before the game starts, i. e, before the outcome of the first stage is known Note that in this game, one has a choice between 25x 80=20 chance to win 000, and a. 25 x1.0=.25 chance to win 3, 000. Thus in terms of final outcomes and probabilities one faces a choice between(4, 000, 20)and (3, 000, 25), as in Problem 4 above. However, the dominant preferences are different in the two problems, Of 141 subjects who answered Problem 10, 78 per cent chose the latter prospect, contrary to the modal preference in Problem 4. Evidently, people gnored the first stage of the game, whose outcomes are shared by both prospects, and considered Problem 10 as a choice between(3, 000)and (4, 000, .80, as in Problem 3 above The standard and the sequential formulations of Problem 4 are represented decision trees in Figures 1 and 2, respectively. Following the usual convention quare denote decision nodes and circles denote chance nodes. The essential difference between the two representations is in the location of the decision node In the standard form(Figure 1), the decision maker fac risky prospects, whereas in the sequential form(Figure 2)he faces a choice between a risky and a riskless prospect. This is accomplished by introducing a dependency between the prospects without changing either probabilities or

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