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What do i choose? Gambling vs insurance: different decision models at stake

My aim with this thesis is to make some clarity on the occurrence of both gambling and insurance, and on the role of economic theory in general. There is much confusion, indeed. In primis, I highlight the boundary between these two concepts, dispelling the idea that buying insurance can be considered a form of gambling, and underlining that they are pole apart actually. Afterward, similarly, I distinguish between normative and positive economics.
In this light, after a brief presentation of expected utility theory, I claim that its failure, as a positive theory, stems from the fact that it yields poor predictions, rather than from the fact that its assumptions are descriptively false. Indeed, the relevant question, to test a positive theory, is not whether its assumptions are realistic but whether they are a good approximation for the purpose. In this sense, only factual evidence can show whether a theory is ’right’ or ’wrong’.
The failure of expected utility theory had a pivotal role in highlighting the importance of psychological factors in economic behavior. Because of the fact that deviations of actual behavior from the predicted one are too widespread to be ignored, too systematic to be dismissed as random error and too fundamental to be set aside, it has been acknowledged that a better psychological understanding was required.
In this light, then, I present some of the evidence that has been fundamental in assessing the obsolescence of expected utility, as a positive theory.
With the idea of accounting for some of these psychological factors, I present prospect theory, which revolutionized decision theory. It was psychologically rich, empirically corroborated and a rigorous account of decision making under risk. The problems with this theory come from the fact that it allows for the choice of stochastically dominated options. In order to make up for such limitation, cumulative prospect theory ensured that decision makers would not choose stochastically dominated options. However, the gains from introducing this new version of prospect theory were somewhat diminished by a substantial loss in psychological realism.
The last model I present is known as composite cumulative prospect theory. In this model, the editing phase and the decision phase are joined into a single phase, thus combining the psychological richness of prospect theory with the more satisfactory attitudes towards stochastic dominance under cumulative prospect theory.
Before drawing the conclusion, I propose a simple application, related to the insurance context, in order to show how composite cumulative prospect theory provides a better account of factual evidence with respect to cumulative prospect theory.
Finally, I draw my conclusion. It is true that expected utility provides a poor account of factual evidence, both for what concerns gambling and insurance in particular and for other phenomena in general. In this sense, of the available alternatives at the moment, composite cumulative prospect theory is possibly the best decision theory, particularly, under risk. Yet, this may not be so relevant. As a matter of fact, what I tried to make clear is that expected utility was conceived of as a normative theory, rather than as a positive one. Thus, it should be tested accordingly. Normative economics deals with ’what ought to be’, and therefore it raises other and different issues with respect to positive economics. To me, it is not surprising, therefore, the fact that this model is poor from a positivisitc standpoint. In the end, it is just a matter of perspective.

Mostra/Nascondi contenuto.
Abstract My aim with this thesis is to make some clarity on the occurrence of both gam- bling and insurance, and on the role of economic theory in general. There is much confusion, indeed. In primis, I highlight the boundary between these two concepts, dispelling the idea that buying insurance can be considered a form of gambling, and underlining that they are pole apart actually. Afterward, similarly, I distinguish between normative and positive economics. In this light, after a brief presentation of expected utility theory, I claim that its failure, asapositivetheory, stemsfromthefactthatityieldspoorpredictions, rather than from the fact that its assumptions are descriptively false. Indeed, the relevant question, to test a positive theory, is not whether its assumptions are realistic but whether they are a good approximation for the purpose. In this sense, only factual evidence can show whether a theory is ’right’ or ’wrong’. The failure of expected utility theory had a pivotal role in highlighting the im- portance of psychological factors in economic behavior. Because of the fact that deviations of actual behavior from the predicted one are too widespread to be ig- nored, too systematic to be dismissed as random error and too fundamental to be set aside, it has been acknowledged that a better psychological understanding was re- quired. In this light, then, I present some of the evidence that has been fundamental in assessing the obsolescence of expected utility, as a positive theory. With the idea of accounting for some of these psychological factors, I present prospect theory, which revolutionized decision theory. It was psychologically rich, empirically corroborated and a rigorous account of decision making under risk. The problems with this theory come from the fact that it allows for the choice of stocha- stically dominated options. In order to make up for such limitation, cumulative prospect theory ensured that decision makers would not choose stochastically do- 1

Laurea liv.II (specialistica)

Facoltà: Economia

Autore: Gianni Ghetti Contatta »

Composta da 90 pagine.

 

Questa tesi ha raggiunto 65 click dal 15/07/2014.

Disponibile in PDF, la consultazione è esclusivamente in formato digitale.