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:
“The morning cup of coffee has an exhiliration about it which the cheering influence of the afternoon or evening cup of tea cannot be expected to reproduce.”
—Oliver Wendell Holmes, Sr. (1809–1894)
“People are capable of doing an awful lot when they have no choice and I had no choice. Courage is when you have choices.”
—Terry Anderson, U.S. hostage. International Herald Tribune (Paris, May 6, 1992)
“Men’s hearts are cold. They are indifferent. Not all the coal that is dug warms the world. It remains indifferent to the lives of those who risk their life and health down in the blackness of the earth; who crawl through dark, choking crevices with only a bit of lamp on their caps to light their silent way; whose backs are bent with toil, whose very bones ache, whose happiness is sleep, and whose peace is death.”
—Mother Jones (1830–1930)