Summary
This article presents several classroom games that help illustrate the effect of risk framing on choices under uncertainty. These games are presented in the context of Kahneman and Tversky's prospect theory that is an alternative to the traditional expected utility theory. Expected utility theory is a prescriptive model of decision making that explains how people should react to risk, while prospect theory is a descriptive model that explains how people actually do react to risk. These classroom games can be used in introductory risk management courses, insurance courses, and financial risk management courses to help students to understand the effect of context on choices made under uncertainty. Although results from actual classroom experiments are included, these results are not meant to be indicative of normal results but are rather illustrative of the type of results that may arise when alternative framing contexts are used.
See the full content of this document
Extract
A Pedagogical Note On Risk Framing
INTRODUCTION
The purpose of this article is to describe a set of classroom games that can be used to illustrate the effects of risk framing on preferences in the presence of risk. Framing refers to how the problem or choice is described. As students become more aware of the effects of framing on preferences, they are better able to fully understand and explain risk management alternatives.Much of the academic literature on optimal choices under risk, and indeed much of the risk management and insurance advice commonly encountered in the nonacademic literature, is based on expected utility theory. Expected utility is a normative, or prescriptive, theory of how individuals should act when faced with uncertain choices. The expected utility theory assumes that individuals are able to accurately quantify various alternatives and make rational decisions based on the value that they assign to each alternative. Rational individuals should act in a manner so as to maximize their utility, with utility being a measure of their desire or preference for one object over another. Individuals are assumed to be able to accurately measure the utility of various alternatives without regard to the manner in which the choices are framed.Individuals are also expected to be consistent in their choices, so that if A is preferred to B and B is preferred to C, then A is also preferred t...See the full content of this document
Sponsored links
