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 strikes me as odd now is how much my father managed to get across to me without those heart-to-hearts which I’ve read about fathers and sons having in the study or in the rowboat or in the car.... Somehow I understood completely how he expected me to behave, in small matters as well as large, even though I can’t remember being given any lectures about it beyond the occasional, undramatic “You might as well be a mensch.””
—Calvin Trillin (20th century)
“Fervor is the weapon of choice of the impotent.”
—Frantz Fanon (1925–1961)
“When a man leaves his mistress, he runs the risk of being betrayed two or three times daily.”
—Stendhal [Marie Henri Beyle] (1783–1842)