Everyone has to make decisions, every day. However, it is not always clear to us what outcomes can derive from these decisions. When this happens, we say we are making decisions in situations under risk or uncertainty. When risk appears, although we are not sure about the possible outcomes of a given decision, we do know the probability of each outcome, while in situations under uncertainty we are not capable of making such assumptions.
In this Learning Path we’ll learn bout risk and uncertainty. We will see how risk can be analysed by using expected utility instead of expected value, and how different kind of people will behave differently when facing risk.
Risk and uncertainty:
Risk, when different outcomes are unknown but individuals can assign them probabilities;
Uncertainty, when individuals cannot assign probabilities to each outcome.
Saint Petersburg paradox, solved by Daniel Bernoulli;
Expected utility, an alternative way to make decisions;
Expected utility theory, developed by John von Neumann and Oskar Morgenstern.
Risk aversion analysis:
Risk aversion, where we analyse different degrees of risk aversion;
Arrow-Pratt measures of risk aversion.