Yvain comments on Prospect Theory: A Framework for Understanding Cognitive Biases - Less Wrong

66 10 July 2011 05:20AM

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Comment author: 10 July 2011 06:22:18AM *  7 points [-]

I am not entirely qualified to answer this objection, and I hope that one day someone who is more mathematical will make a post on the exact math involved.

Until then, I would say that the important part of prospect theory is not fitting numbers to the curves or determining the exact curve for each different person, but the discovery that the curves have the same basic shape in everyone. For example, that the slope of the losses curve is always greater than the slope of the gains curve; that the slope of both curves is steepest near zero but eventually levels out; that gains are always concave and losses are always convex. That subjective probability is steepest near zero, and also steep near one, but flatter in the middle. That decisions depend on frames, which can be changed and scaled depending on presentation.

I'm describing these visually because that's how I think; in the paper I linked to on top, Kahneman and Tversky describe the same information in the terms of mathematical equations which expected utility follows. None of these are intuitively predictable without having done the experiment, and all of them are pretty constant across different decisions.

I'm not sure what the status of research on applied prospect theory - figuring out the exact equations you can plug a frame and an amount of money into and predict the decision - is, but it must have had some success to win a Nobel Prize.

Comment author: 10 July 2011 08:10:03PM 1 point [-]

We already knew that losses weigh roughly 2-3x (I forget which) as heavy as gains.

It's interesting but not surprising that people can re-orient losses and gains by framing.

It does make sense that the subjective value of monetary gains and losses should be more steeply sloped around 0, to the extent that emotional pain/reward needs to be strong enough in order to guide decisions even for small amounts of money (as in everyday transactions), but the dynamic range of the physical systems that register these feelings is limited. So we expect the magnitude of the slope to decrease as the quantities grow larger.

I wonder what happens to people who invest and manage to reframe their losses and gains as being percentage-of-total-wealth? We shouldn't accept that the only allowed frames are those that shift the origin.

It is interesting to point out that people act by weighting outcomes with a subjective probability that consistently differs from the actual information available to them. I'd like to understand the evidence for that better, but it's plausible - I can imagine it following from some fact about our brain architecture.

I'd be more impressed with the theory if it could really identify a characteristic of a person, even in just the domain of monetary loss/gain, such that it will predict future decisions even when that person is substantially poorer or richer than when the parameters were fit to them.