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:
“When we see a natural style, we are astonished and delighted; for we expected to see an author, and we find a man.”
—Blaise Pascal (1623–1662)
“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)