- [[prospect theory]]: alternative to EU - [[prospect]] - applies to valuation under **risk** [[decision risk vs ambiguity or uncertainty]], [[linear random utility model]] # Idea Proposed by [[Daniel Bernoulli]] in 1738. A theory that states that the value of a [[prospect]] (or of random rewards) equals the sum of the value of the potential outcomes weighted by their probability. The value of a prospect equals the sum of the value of the individual outcomes, $v(x)$, weighted by their objective probability $p(x)$. $value = \sum_{x} p(x)v(x)$ Decision makers select the course of action that yields the greatest sum (i.e., expected utility). EU also assumes that the utility of a particular outcome isn't simply based on the outcome, but rather on all the assets accumulated to that point. [[Loewenstein 2008 Neuroeconomics]] > p651. Consider, for example, a gamble that offers a 50% chance of winning $20 and a 50% chance of losing $10. If your current wealth totals $1 million, then EU assumes that you view the gamble as offering a 50% chance of experiencing the utility of $1,000,020 and a 50% chance of experiencing the utility of $999,990. But subsequently, the above idea has been revised, such that utility as evaluated as gain/losses relative to a reference point. Studies have found neural responses that correlate with [[expected value]] [[Platt 1999 neural correlates of decision variables in parietal cortex|(Platt & Glimcher, 1999)]]. ![[Pasted image 125.png]] # References - [[Loewenstein 2008 Neuroeconomics]] - https://saylordotorg.github.io/text_risk-management-for-enterprises-and-individuals/s07-01-utility-theory.html