= 27d567bc2d48d9f40e9ccc20ea370b15)
DanielLC comments on Prospect Theory: A Framework for Understanding Cognitive Biases - Less Wrong
You are viewing a comment permalink. View the original post to see all comments and the full post content.
= 783df68a0f980790206b9ea87794c5b6)
Loading…= b715d02e85f7b3b4ae65ca3d3e450868)
Subscribe to RSS Feed
Powered by Reddit
= f037147d6e6c911a85753b9abdedda8d)
You are viewing a comment permalink. View the original post to see all comments and the full post content.
Comments (46)
This post mis-uses the term "utility". Expected utility theory does not treat utility as linear in money, as you suggest.
See http://en.wikipedia.org/wiki/Von_Neumann%E2%80%93Morgenstern_utility_theorem, or perhaps also
http://lesswrong.com/lw/244/vnm_expected_utility_theory_uses_abuses_and/
The main descriptive difference between prospect theory and EU theory is that for monetary decisions, EU theory uses one curve (utility function), whereas prospect theory uses two curves (a value function and weight function) as well as a framing variable... it's about three times as suspect for overfitting, so I think I'll wait until it pays a little more rent :)
Utility is generally accepted to be differentiable in money, which means that it's approximately linear in amounts that are insignificant over your lifetime earnings. If you use a non-linear utility to explain risk aversion for a small amount of money, and extend this until you get large amounts of money, it results in absurdly huge utility falloff. I remember someone posted an article on this. I can't seem to find it at the moment.
Unless you have a good estimate of your future earnings and can borrow up to that at low interest rates, I think "amounts that are insignificant compared to your current liquidity" might be a slightly more rational metric. Note also that any explanation of human risk aversion (as opposed to rational risk aversion) is trying to explain behaviors that evolved during a time when "borrowing at low interest rates" wasn't really an option. If a failed risk means you starve to death next year, it doesn't matter how copious a quantity of food you otherwise would have acquired in subsequent years.
http://lesswrong.com/lw/9oe/risk_aversion_vs_concave_utility_function/5svv
Are you looking for this?