Have a go at this one

Alright, I'ma post some questions and I want people to answer both of them. Nothing special, just satiating my curiosity. 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
 
Yep, we hate losing more than we like winning.

Another simple way to consider this is another "study' done.

Using a normal coin, heads one side, tails the other, people where asked on the flip of the coin, if a wrong call meant you would lose $100, what would you need to win to particpate.

Most said at least $150. Some said $200.

One genius though said $60. Now there's a gambler, betting odds on for an even chance bet.


As Andew alluded to, it's why we sit on our dud shares. We don't want to incur the actual loss.

GarryK
 
Hey lads,

Good stuff there. I've been reading about behavioural finance the last few days and am fascinated by it. It's where I got the questions from. Surprised no one wants to give it a go, there's no real 'right or wrong' answers, just a gauge of people's investing views and risk profiles. Anyway, hopefully at least a few people will give it a go.

Mark
 
For me ..

1) Either .. I've already made something from nothing so i'm happy. With low numbers I would tend towards B, with high $$ I would tend towards A.
2) A every time.


ps ..

http://www.behaviouralfinance.net/

See also Gamblers Fallacy, Loss Aversion, Framing.

You read about these things from time to time in various newsletters and books.

I think I may just ring a few more REAs instead of reading all that though.
 
On average A and B of both will produce the same outcome; the less certain option (B) becoming more like the sure option (A) as the number of times the choice is repeated increases.

I suspect in the first 'no lose' scenario most participants would choose A, whereas in the 'no win' scenario more would choose B, for reasons others have mentioned.

This would tend to limit the upside and exaggerate the downside if the toss is unfavourable.

As opposed to investors who aim for a high 'no limit' upside, while seeking to quantify, control and limit losses.

Possibilities:

1. (start with certain $500 gain)
Gain $500, lose $500 = $0
Gain $500, lose $0 = +$500
Gain $500, lose $1000 = -$500

2. (50% chance on a $1000 gain)
Gain $1000, lose $500 = +$500
Gain $1000, lose $0 = +$1000
Gain $1000, lose $1000 = $0

3. (50% chance on a $0 gain)
Gain $0, lose $500 = -$500
Gain $0, lose $0 = $0
Gain $0, lose $1000 = -$1000

Peter
 
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Mark,

A in both thanks.

In answer to Garry K's question on how much I'd need to be able to win to bet on a toss where you lose $100, I reckon $101 might do it for me. Particularly if I could bet as many times as I like.

Cheers,
Michael.
 
Personal intervention adds value?

Here's a real experiment, paraphrased for brevity.

Baseline: Pick a card from a deck of ten (no touching). The card is returned to the deck. You are then told that if your card is pulled out, it'll win $100. Next, you are asked how much you would sell your card for.

Most people, logically, say their card is "worth" $10.

The experiment: Pick a card from a deck of ten as above. This time you are allowed to hold it and fix it in your mind. The card is returned to deck, the $100 prize is mentioned and you are asked how much would you sell the card for. The price increases to $11 or $12, despite the only variable changed being physical contact and bonding.

The suggestion is that we tend to put a higher value on things we are personally involved with. Know of someone whose perception of the value of their car/house/shares is higher than market, for no objective reason?

Something to keep in mind...? ;)
 
Mark Laszczuk said:
Alright, I'ma post some questions and I want people to answer both of them. Nothing special, just satiating my curiosity. 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

1. B - happy with a grand, and there's a chance I might get more.
2. B - well, if I lose it, I still have a grand. And I still might get to keep the lot.

I wonder if the decision change once the zero's on the end increase though?

e.g.
You are given $1 million......

Cheers,

The Y-man
 
The Y-man said:
1. B - happy with a grand, and there's a chance I might get more.
2. B - well, if I lose it, I still have a grand. And I still might get to keep the lot.

I wonder if the decision change once the zero's on the end increase though?

e.g.
You are given $1 million......

Cheers,

The Y-man

I'm with you on both counts. Put three extra zeros on it and I will take the certainties every time. I haven't thought about the midrange.
 
Hiya Mark,

1. $1,000 or $2000 only, lah?...not enough motivation to "excite" me and so my brain got "bored" and it refuses to work... soory!... Just a bad joke.

2. I guess if you start to vary the amount of monies involved to a much bigger amount, you will probably get different responses from the same person responding to your question.... at least you will see that from me, I guess.

3. If I really have to choose from what you have presented, I will tell you straight that I will not want to get involved in the game at this level at all as it is not the level that "excites" me, to make a decision or/and worth my while and time.

4. To me, the Prospect Theory is merely academic and one of statistical probability and though quite an interesting social phenomenon, it may not be accurately reflect what the people actually do in their real lives, especially for those who strongly believed in themselves and especially among the high risk-takers.

6. For such kind of people like myself, sometimes, it is not the winning or losing that actually attracted me, it is actually being in the game itself, being part of/staying the game itself.

7. For your kind update, please.

8. Thank you.

Cheers,
Kenneth KOH
 
Kenneth it very accurately predicts what people do in their real lives.

I struggle with this bias almost every trading day, in fact I'm struggling now (must resist.. taking profits..) :)

One individual might be an exception but take a large sample and the truer it will become.

Edit ... And it's very true that the amount of money changes things, this is another theory know as utility theory.

New Scientist Article
 
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