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WIREs Cogn Sci
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Risk attitude and preference

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Abstract Citizens of Western countries are asked to make an increasing number of decisions that involve risk, from decisions about how much and how to save for their old age to choices among medical treatments and medical insurance plans. At the same time, uncertainty about choice outcomes has gone up as the result of ever faster social, environmental, and technological change. Accuracy in predicting what choices people will make, at least in the aggregate, is an important determinant for the success of public policy interventions. In addition, corporate and public policy often tries to influence and modify people's choices in the face of risk and uncertainty, for example, getting people to save more of their income or getting women to invest in less conservative instruments. Understanding the processes that underlie risky decisions and the drivers of risk taking is critical to both agendas. Copyright © 2009 John Wiley & Sons, Ltd. This article is categorized under: Economics > Individual Decision-Making Psychology > Reasoning and Decision Making

In the St Petersburg paradox game, a fair coin is tossed until the first head is scored. The payoff depends on the trial at which the first head occurs, with $ 2 if on the first trial, $ 4 if on the second trial, and $ 2n if on the nth trial, as shown in this figure, together with the probability of each outcome. The EV of the game is infinite: .

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The value function of prospect theory, where outcomes are defined as gains or losses relative to a reference point, with a concave function for gains and a convex and steeper function for losses.

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Constant absolute risk aversion (CARA, left column) and constant relative risk aversion (CRRA, right column). The top panel shows the described utility function, the bottom panel its first and second derivative.

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Example of a concave utility function u(x) = x0.5 which converts wealth, x, into its utility u(x). An increase in wealth from $ 0 to $ 10,000 is shown to result in a greater increase in utility than an increase in wealth from $ 20,000 to $ 30,000.

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Psychology > Reasoning and Decision Making
Economics > Individual Decision-Making

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