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Perception of probabilities in situations of risk: A case based approach

  • Gayer, Gabrielle
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    This paper provides a description of a possible mental process individuals go through in their attempt to comprehend stated probabilities in simple lotteries. The evaluation of probabilities is based on the following main components: lotteries encountered in the past, the realizations of these lotteries, and the similarity between stated probabilities. A probability is evaluated based on the experienced relative frequencies of outcomes that had that stated probability, as well as outcomes of other lotteries that had similar stated probabilities. This process may result in distortion of probabilities as observed in the literature, and in particular, in overvaluing low probabilities and undervaluing high probabilities. If the decision maker uses a less permissive similarity function as the size of memory grows, she will learn the real value of the stated probabilities. If, however, the similarity function is independent of memory, biases persist even when data are accumulated.

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    File URL: http://www.sciencedirect.com/science/article/B6WFW-4W9XBDP-1/2/77cca4683772d97b5546ad9d5fa4484d
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    Article provided by Elsevier in its journal Games and Economic Behavior.

    Volume (Year): 68 (2010)
    Issue (Month): 1 (January)
    Pages: 130-143

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    Handle: RePEc:eee:gamebe:v:68:y:2010:i:1:p:130-143
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622836

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    1. Quiggin, John, 1982. "A theory of anticipated utility," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 323-343, December.
    2. Itzhak Gilboa & David Schmeidler, 2003. "Inductive Inference: An Axiomatic Approach," Econometrica, Econometric Society, vol. 71(1), pages 1-26, January.
    3. Itzhak Gilboa & Offer Lieberman & David Schmeidler, 2004. "Empirical Similarity," Levine's Bibliography 122247000000000684, UCLA Department of Economics.
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    5. Chew, Soo Hong, 1983. "A Generalization of the Quasilinear Mean with Applications to the Measurement of Income Inequality and Decision Theory Resolving the Allais Paradox," Econometrica, Econometric Society, vol. 51(4), pages 1065-92, July.
    6. Billot, Antoine & Gilboa, Itzhak & Schmeidler, David, 2008. "Axiomatization of an exponential similarity function," Mathematical Social Sciences, Elsevier, vol. 55(2), pages 107-115, March.
    7. Antoine Billot & Itzhak Gilboa & David Schmeidler & Dov Samet, 2004. "Probabilities as Similarity-Weighted Frequencies," Cowles Foundation Discussion Papers 1492, Cowles Foundation for Research in Economics, Yale University.
    8. Rubinstein, Ariel, 1988. "Similarity and decision-making under risk (is there a utility theory resolution to the Allais paradox?)," Journal of Economic Theory, Elsevier, vol. 46(1), pages 145-153, October.
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    11. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
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    13. Guerdjikova, Ani, 2008. "Case-based learning with different similarity functions," Games and Economic Behavior, Elsevier, vol. 63(1), pages 107-132, May.
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    15. Frederick Mosteller & Philip Nogee, 1951. "An Experimental Measurement of Utility," Journal of Political Economy, University of Chicago Press, vol. 59, pages 371.
    16. Yaari, Menahem E, 1987. "The Dual Theory of Choice under Risk," Econometrica, Econometric Society, vol. 55(1), pages 95-115, January.
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