Study Guide for Final

Disappointment Aversion

1. Define these terms: Disappointment, Elation, Regret, and Rejoicing

1. Disappointment – A Bad outcome experienced as a result of the State of The
World
2. Elation – A Good outcome experienced as a result of the State of The World
3. Regret – A Bad outcome experienced as a result of A Decision
4. Rejoicing – A Bad outcome experienced as a result of A Decision
2. Know how a disappointment averse agent calculates the rational expectation value
of a lottery.
1. V(I) = p*u(x) + (1-p)*u(y) – (1-p)B[V(I)-u(y)]

Ambiguity

1. What is the distinction between risk and uncertainty?

a. Risk – Probability is known
b. Uncertainty – Probability is unknown
2. What is the “sure thing principle”?
a. We compare two acts, which are functions from states of the world to
outcomes. If the two acts are equal on a certain event A, then the preference
between them should only depend on their value off of A.
3. What is Ellsberg’s Paradox? What are the possible explanations?
a.
4. Provide examples for the consequences of ambiguity aversion in real-life?
a. Excessive Brand Loyalty, Home Country Investment Bias, Incomplete
Contracting
5. What is bid-ask spread in asset markets? How does ambiguity aversion explain bid-
ask spread?
a. It is the “Do Nothing Zone” caused by ambiguity aversion between possible
outcomes of a security. If comes with a pessimistic attitude that people will
always get the worst outcome

Time Preference

1. Give an example of a time inconsistent behavior.

1. You say you will eat healthy next week, but when next week comes, you eat
mcdonalds. Procrastination
2. What are the basic assumptions of Exponential Discounting (ED)?
1.
3. What are the differences between ED and QHD (Quasi-hyperbolic discounting)?
1. ED tries to fit too much into the delta term, while it accounts for long run.
QHD is able to account for long run as well as short run.
4. How does behavior of Naïve and Sophisticated decision-makers differ?
1. Naïve people are not conscious of their commitment issues, while
sophisticated agents can predict their actions and therefor change them.
5. What are affective and deliberative systems in decision making? Explain their role in
self-control problems by providing an example.
1.
 6. Provide an example where time-inconsistency of people may provide a reason for
government intervention.
1.

Social Preferences

1. What is the difference between selfish and social preferences?

2. Explain the Ultimatum game
3. What should be the behavior of selfish proposers in an Ultimatum Game?
4. What is the observed behavior of proposers in an Ultimatum Game?
5. What are the factors affecting social preferences in an Ultimatum Game?