Prospect theory

[Euler]

If you want an insight into how people make bad decisions check out Prospect theory: -

https://en.wikipedia.org/wiki/Prospect_theory

Prospect theory is a behavioral economic theory that describes the way people choose between probabilistic alternatives that involve risk, where the probabilities of outcomes are known. The theory states that people make decisions based on the potential value of losses and gains rather than the final outcome, and that people evaluate these losses and gains using certain heuristics. The model is descriptive: it tries to model real-life choices, rather than optimal decisions, as normative models do.

The theory was created in 1979 and developed in 1992 by Daniel Kahneman and Amos Tversky as a psychologically more accurate description of decision making, compared to the expected utility theory. In the original formulation, the term prospect referred to a lottery. The paper "Prospect Theory: An Analysis of Decision under Risk" (1979) has been called a "seminal paper in behavioral economics".[1]

Here is the original paper: -

https://www.princeton.edu/~kahneman/doc ... theory.pdf

[giblespaul89]

This stuff is fascinating.... just going through 'Thinking, Fast and Slow' and recognise the author.

One of the things that I've started getting interested in is the 'edge' and downsides of the human brain. Been looking into the results that quantitive trading has delivered for hedge funds such as Renaissance Technologies and how automation has essentially killed day trading in financials, at least for a lot of the investment banks. However machines seem to struggle with long positions and not dissimilar to predicting the 'swing' in racing. There are clear paths which benefit the human aspect of trading.

I think the battle going forward between automated trading systems and human based trading will be a very interesting one to watch. You can see elements of that playing out in exchanges too.

[Euler]

I spotted a comment from Kahneman over the weekend on a blog: -

https://replicationindex.wordpress.com/ ... mment-1454

[mjmorris335]

I spotted a comment from Kahneman over the weekend on a blog: -

https://replicationindex.wordpress.com/ ... mment-1454

I bought the book a couple of weeks ago, planning to read it when I've got a bit more time on my hands (turns out that's sooner than I thought thanks to my impending redundancy). If I understand his post correctly - and I haven't had the time to do more than skim it - there are several chapters which reference priming effects which can't be relied upon evidentially due to inadequate sample sizes of various studies. I wonder if that's going to affect his other conclusions going forward.

Mike