Summary of Thinking, Fast and Slow by Kahneman - 1st edition
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Why is 'Prospect theory' better than 'Utility theory' in understanding the evaluation of financial outcomes? – Chapter 26
What is the prospect theory? – Chapter 26
In utility theory, the utility of a gain is determined by comparing the utilities of two states of wealth. The utility of receiving an extra € 400 when your wealth is € 2 million is the difference between the utility of € 2.000.400 and the utility of 2 million. If you lose € 400, the disutility is again the difference between the utilities of both states of wealth. It was assumed that the distinction between losses and gains did not matter and was not examined due to the theory-induced blindness.
Kahneman and Amos had focused on differences between gambles with low or high probabilities of winning, until Amos casually mentioned the losses. The risk aversion turned out to be replaced by going for the risk. Consider the following problems:
1. Which do you prefer? Get € 800 for sure or a 90% chance to get € 900.
2. Which do you prefer? Lose € 800 for sure or 90% to lose € 900.
The first problem induces risk aversion, you would go for gaining € 800. In case of the second problem, you will probably go for the gamble (the risk). When all options are bad, people tend to become risk seeking.
The comparison between the problems emphasize the importance of the reference point: the previous state relative to which losses and gains are evaluated. Reference points usually get ignored by people and Bernoulli’s theory lacks them. The prospect theory takes reference points into account. The prospect theory involves three cognitive features (associated with System 1), which play a crucial role in the evaluation of financial outcomes and are common to a lot of automatic processes of emotion, judgment and perception:
Evaluation is relative to a neutral reference point (‘adaptation level’).
A principle of diminishing sensitivity applies to the evaluation of changes of wealth and to sensory dimensions.
Loss aversion.
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Summary of Thinking, Fast and Slow by Kahneman - 1st edition
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Summary of Thinking, Fast and Slow by Kahneman - 1st edition
- What is the book 'Thinking, fast and slow' by Kahneman about?
- What distinguishes fast and slow thinking? - Chapter 1
- How do fast and slow thinking deal with effortful tasks? - Chapter 2
- How does the 'lazy control' of slow thinking work? - Chapter 3
- How does the 'associative machinery' of fast thinking work? - Chapter 4
- When is your mind at ease? - Chapter 5
- How does your mind deal with surprises? - Chapter 6
- Why do people so often jump to conclusions? - Chapter 7
- How are your judgments formed? – Chapter 8
- How do you generate an intuitive opinion on a complex problem? – Chapter 9
- When should researchers be more suspicious of their statistical intuitions? – Chapter 10
- How do unknown quantities enhance bias in your mind? – Chapter 11
- How do unknown frequencies enhance bias in your mind? – Chapter 12
- How do risk and availability enhance bias in your mind? - Chapter 13
- How do you prevent false intuitive judgement? - Chapter 14
- How is fallacy formed in you mind? - Chapter 15
- How does causally connected storytelling enhance bias in you mind? - Chapter 16
- How does causal interpretation enhance bias in you mind? - Chapter 17
- How can you tame and correct your intuitive predictions? - Chapter 18
- Why is every success story you read or hear often wrong? - Chapter 19
- How does the illusion of validity make you overconfident in your ability to predict the future? - Chapter 20
- How can you use statistics to correct intuitions? - Chapter 21
- When do your judgments reflect true expertise? – Chapter 22
- What is the importance of the 'outside view' versus the 'inside view' for your judgements? – Chapter 23
- What is the best remedy for overconfident optimism? – Chapter 24
- How does your valuing relate with actual value? – Chapter 25
- Why is 'Prospect theory' better than 'Utility theory' in understanding the evaluation of financial outcomes? – Chapter 26
- Why is 'Prospect theory' better than 'Utility theory' in understanding the endowment effect of valuing valuables? – Chapter 27
- How is your decision-making affected by avoiding a loss and achieving a gain? – Chapter 28
- How is your decision-making affected by the value you attribute to losses, gains and wealth? – Chapter 29
- How is your decision-making affected by rare events? – Chapter 30
- How can you remedy the exaggerated caution evoked by loss aversion and the exaggerated optimism of the planning fallacy? – Chapter 31
- How do you keep mental account of gains, losses and regret? – Chapter 32
- When do preference reversals occur? - Chapter 33
- How is your decision-making affected by words that induce emotion? - Chapter 34
- How can our memory affect our judgments of experiences? - Chapter 35
- How does our memory affect our choices? - Chapter 36
- What does research about experienced well-being learn us? – Chapter 37
- How does your thinking affect your experience of happiness? – Chapter 38
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Summary of Thinking, Fast and Slow by Kahneman - 1st edition
Summary per chapter with the 1st edition of Thinking, Fast and Slow by Kahneman
- What is the book about?
- Part 1: How do fast thinking and slow thinking work? Chapters 1-9
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