Thinking, Fast and Slow. 26. Prospect Theory

Following the schedule of our Reading Calendar

This chapter presents us with a detailed description of prospect theory which should address the deficiencies that, as we saw in chapter 25, the 250 year-old utility theory presented.

Instead of calculating the utility that a certain amount of money represents for a person just putting it in relation with the person’s wealth, prospect theory uses a different approach to predict human preferences. It is based in three principles:

1. Evaluation is relative to a neutral reference point which is not the wealth of the person involved but is a characteristics of the choice presented to it and the expectations of gains and losses that it generates.

2. There is diminishing sensitivities to both losses and gains.

3. Perceived utility is asymmetrical for gains and losses being much bigger for the latter. This is loss aversion and is the basic point of the chapter.

Here comes to my mind Taleb, the story teller, when he explains that if you look at your portfolio once in a year, you see that you are up 5% and you are happy. But if you look everyday, almost half of the days you are losing money and you live a miserable life because the bad feelings that you get are not offset by what you get the days that you are up.

And talking of Taleb the Impaler, the chapter ends with a strange final section where the Kahneman tries somehow to recover the value of utility theory after all the bashing that it has received in the last two chapters. I kind of false modesty, probably, to soften relationships with some colleges. This is something Taleb has never done.

God bless him.

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3 thoughts on “Thinking, Fast and Slow. 26. Prospect Theory

  1. I agree. Thanks Taleb for not compromising and making his points straight. But then sometimes it backfires. In Twitter some months ago someone told him that he was like Donald Trump, they just say what they think, no BS. Of course just saying what you think is not enough, like when you are a moron like Trump.
    But then, there is a some tension between always having a point of view about anything and talking about impredictibility of the world. Sometimes I have the feeling that Taleb just jumos into the ring with just a bunch of prejudices and no solid arguments against someone.
    Still, it is better than smashing a theory and then trying to say that it wasn’t that bad.

  2. Well, Taleb is great for its entertainment value and the powerful way he has of conveying ideas and also, of course, for the depth and quality of some of his insights. However, I guess, that if I had to choose between Taleb or Kahneman as a neighbour, room mate or work colleague, I would probably choose the boredom.

    Taleb, by the way and mixing issues, changed this opinion on Trump in tweeter for example. So sometimes he shows some flexibility. His initial critiques surprised me because Trump is Fat Tonny in politics. Unpredictable, gains with attacks and critiques. A kind of black Swan, in fact. And do you really think he is a moron?

  3. I can’t really tell about Trump. Some of the things he does and say sound quite moronic. But it also sounds that most of the things he says are crafted to reach his public, and make his public grow.
    One thing is for sure: as you said he is antifragile indeed, growing stronger at every attack and critique

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