Analyzing Background Risk with Morgan Dollars

Their have been much economic research to determine how individuals evaluate risk. Most of this work takes place in a laboratory setting using hypothetical monetary payoffs. Further, the issue of “background risk” is often ignored. For instance, “…mortality risks from alternative occupations tend to be highly correlated with morbidity risks. It is implausible to ask…

Prospect Theory

Yesterday, I talked about expected utility theory (EUT). Today I will write about one on the major departures from EUT: Prospect Theory. This theory was developed by Nobel laureate Daniel Kahneman and Amos Tversky (Econometrica 1979). The four key characteristics of prospect theory are: Individuals use decision weights, π(p), rather than probabilities, p, when making…