Prospect relativity: How choice options influence decision under risk.

Abstract

In many theories of decision under risk (e.g., expected utility theory, rank dependent utility theory, and prospect theory) the utility or value of a prospect is independent of other prospects or options in the choice set. The experiments presented here show a large effect of the available options set, suggesting instead that prospects are valued relative to one another.The judged certainty equivalent is strongly influenced by the options available. Similarly, the selection of a preferred option from a set of prospects is strongly influenced by the prospects available. Alternative theories of decision under risk (e.g., the stochastic difference model, multialternative decision field theory, and range frequency theory), where prospects themselves or prospect attributes are valued relative to one another, can provide an account of these context effects.

Does the brain calculate value?

“…Some researchers argue instead that these effects are due to a human inability to represent absolute magnitudes, whether perceptual variables, utilities, payoffs, or probabilities [28,46]. The most recent type of comparative theories assumes that people make judgments and decisions 13 without consulting a utility scale based on the absolute magnitudes of stimuli (even for key ‗economic' variables such as time and probability) [13].…”

“…For example, the perceived value of a risky prospect (e.g., -p chance of x‖) is relative to other prospects with which it is presented, which is known as ‗prospect relativity' [28]. In particular, when judging the value of ‗50% chance of winning £200' and respondents have options of £40, £50, £60, and £70, the most popular choice is £60.…”

“…Such assumptions underpin much current economic practice, such as the use of contingent valuation methods to compare otherwise incommensurable goods (lower pollution; more car ownership) by relating them into a common ‗currency' (i.e., money). However a huge range of challenges such models is given by empirically observed context effects (e.g., ‗preference reversals' [26,27]; ‗prospect relativity' [28]; memory effects [29]). Box 1 presents recent evidence for a specific type of context effect that implies lack of context independent value-based judgments.…”

On the Origin of Utility, Weighting, and Discounting Functions: How They Get Their Shapes and How to Change Their Shapes

“…Beauchamp et al (2012), Birnbaum (1992), and Stewart et al (2003) found that when valuing a risky gamble, people were influenced by the range and skew of the options available as potential valuations. For example, Birnbaum (1992) valuation of a target gamble was higher when people selected a valuation from a negatively skewed set than from a positively skewed set.…”

“…Benartzi and Thaler (2001) account for this pattern with the 1/n heuristic, which assumes people place equal funds into each option, but the allocation is also compatible with the rank hypothesis. Stewart et al (2003) examine a laboratory analogue, where people are offered either five risky options or five safe options. Participants in the different conditions behaved as though they had different levels of risk aversion, even though participants were randomly assigned to different groups.…”