Expected Value and Choice Under Risk
In the presence of risky outcomes, a decision maker could use the expected value criterion as a rule of choice: higher expected value investments are simply the preferred ones. For example, suppose there is a gamble in which the probability of getting a $100 payment is 1 in 80 and the alternative, and far more likely, outcome, is getting nothing. Then the expected value of this gamble is $1.25. Given the choice between this gamble and a guaranteed payment of $1, by this simple expected value theory people would choose the $100-or-nothing gamble. However, under expected utility theory, some people would be risk averse enough to prefer the sure thing, even though it has a lower expected value, while other less risk averse people would still choose the riskier, higher-mean gamble.
Read more about this topic: Expected Utility Hypothesis
Famous quotes containing the words expected, choice and/or risk:
“What is a country without rabbits and partridges? They are among the most simple and indigenous animal products; ancient and venerable families known to antiquity as to modern times; of the very hue and substance of Nature, nearest allied to leaves and to the ground,—and to one another; it is either winged or it is legged. It is hardly as if you had seen a wild creature when a rabbit or a partridge bursts away, only a natural one, as much to be expected as rustling leaves.”
—Henry David Thoreau (1817–1862)
“Utah is the only State that gives condemned men a choice between death by hanging or before a firing squad. Most prisoners prefer the firing squad, but one obstinate convict in 1912 elected to be hanged because “hanging is more expensive to the state.””
—State of Utah, U.S. public relief program (1935-1943)
“A monarch must sometimes rule even himself: he who wants everything must risk very little.”
—Pierre Corneille (1606–1684)