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Glossary + examples Judgment and Decision Making E_BK3_JDM
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Glossary + examples Judgment and Decision Making E_BK3_JDM
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Expected utility theory = assumes that logic prescribes how decisions should be made.Normative theory = prescribes how people “ought” to make decisions in a perfectly rational
way, and many implicitly assumed that most people, in daily lives, follow normative rules.
Dominance principle = alternative gambles can be ranked from best to worst in terms of
expected value.
Cancellation = a choice between gambles should depend on only those outcomes that
differ.
Transitivity = if you prefer A to B and B to C, then you must prefer A to C.
Invariance = preference should remain invariant or stable, no matter how choices are
described. → no framing effect
Prospect theory = that investors value gains and losses differently, placing more weight on
perceived gains versus perceived losses.
Risk aversion = the tendency of people to prefer outcomes with low uncertainty to those
outcomes with high uncertainty.
Reference point = determines how an outcome is perceived.
Sensitivity = if it is already bad, it doesn’t matter if it gets slightly worse
Example prisoner. If he gets a smaller cell, it doesn't matter much because his
reference point is already low. Someone entering prison has freedom as a reference
point, so the small cell feels more like a loss
Loss aversion = the disutility associated with a loss is larger than the utility associated with
a gain with the same magnitude.
Framing effect = a cognitive bias where people decide on whether the options are
presented with losses or gains.
Descriptive decision analysis = how people actually make decisions → prospect theory.
Certainty effect = reduction of probability of an outcome by a constant factor has more
impact when the outcome was initially certain than when it was merely probable.
, Pseudocertainty effect = the tendency for people to perceive an outcome as certain while it
is actually uncertain in multi-stage decision making.
Status quo = we want to keep things the way they are and we want to avoid potential losses
generated by chance. Losses loom larger than gains.
Mental accounting = the set of cognitive operations used by individuals and households to
organize, evaluate, and keep track of financial activities.
Opening and closing accounts = decision when to leave accounts “open” and when
“close”.
Perceiving outcomes = how outcomes are perceived and experienced, and how decision is
made and subsequently evaluated.
Transaction utility = the perceived value of the deal = price paid – reference price
Example beer from hotel vs supermarket. The reference price is different for the two
same beers.
Acquisition utility = measure of the value of the good obtained relative to its price = value
(receiving good as gift) – price paid
Disposition effect = the tendency of investors to hold on to losing investments and selling
winners to early. Occurred by mental accounting and prospect theory/loss aversion.
Payment depreciation = a gradual reduction in relevance of prior expenditures
gym membership
Payment decoupling = consumption which has been previously paid for can be enjoyed as
if it were free.
paying with creditcard or afterpay
Sunk cost effect = arises when a decision is referred to an existing account in which the
current balance is negative.
Budgeting = the assignment of activities to special accounts.
Consumption categories = people divide spending their money into different
categories.
Self-control = people reduce their budgets on purpose to avoid temptations
Income accounting = people tend to match the money they get from a windfall with
the use of which it is put.
+ gift giving, gift cards & wealth accounts
Choice bracketing = concerns the frequency with which accounts are evaluated. How
choices are grouped together.
Think about what you will eat throughout the week, so that you eat varied food
throughout the week and get different and enough nutrients.
House money effect = after a prior gain, people become more open to assuming risk.
When you invest money in shares, and make a profit from this, you are more likely to
invest the profit in riskier shares than the money you put into the first shares.
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