Suppose Martin is a risk-averse expected utility maximizer. In contrast, Roberto

Question

Suppose Martin is a risk-averse expected utility maximizer. In contrast, Roberto evaluates gambles according to prosspect theory with (p) = p and a value function that has the three properties suggested by Kahneman & Tversky.

Consider the following four choice situations:

For each choice, describe for both Martin and Roberto whether we can determine which option they will choose or whether we need more information.

Choice (i): ( $8000. ; $2000. ) vs. ( $2800. 1 ) Choice (i): (-$80o,.3; -s400, J) vs. (-$550,1) Choice lii): (-$1700, 1; sO, 2) vs. (-$875,1) Choice (iv): -$200,3;$800, 3 ) vs. (S0,1)

Explanation / Answer

It is clear that the Martin will choose option 1) because in the option 1) the expected utility is [(8000)*(1/8)+(2000)*(7/8)] = 2750. So, for Martin, all the required information is given but for the Roberto, we need some additional information that is the value function is not given and the respective utility function.

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