Boom and Bust

Topics: Prospect theory, Risk aversion, Amos Tversky Pages: 2 (308 words) Published: August 22, 2013
the financial economic impact of a boom and bust

The economic study performed in 2012 by Fryer in the United States found that loss eversion motivates teachers aversion motivates teachers far more then strongly than just the prospect of receiving a reward (cash), despite the net gains being the same to them. The findings of this study indicate that the teachers are deviating from expected utility. This is a result of the theory of loss aversion. The theory of loss eversion was first demonstrated by economist Amos Tversky and Daniel Kahneman. This economic, states that people value gains and losses differently and as a result will make their decisions on perceived gains rather than perceived losses. For example if you give an individual two equal choices, one of these choices is a gain and the other in possible losses, the individual would choose the latter (Bleichrodt, 2007).

people interpret outcomes as gains and losses relative to a reference point and are more sensitive to losses than to absolutely commensurate gains.

Economic analyses of decision under risk commonly assume that people maximize expected utility. Much empirical evidence suggests, however, that people systematically violate expected utility theory (Camerer 1995; Starmer 2000). For example, measurements of utility under expected utility have often led to inconsistencies (Hershey and Schoemaker 1985). Rabin (2000) showed that the commonly observed degree of risk aversion over small stakes implies an unrealistic degree of risk aversion over large stakes under expected utility. The danger of using biased utilities is, obviously, that predictions of decisions will be distorted. Many empirical studies have found evidence of loss aversion (e.g. Kahneman et al. 1990; Tversky and Kahneman 1991; Barberis et al. 2001).

Referencing

Bleichrodt, H. 2007. Loss Aversion under Prospect Theory: A Parameter-Free Measurement. [Online]. Available:...
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