Question

20) Which of the following are consistent with the tenets of Prospect Theory?

a) A dollar loss is LESS painful than the satisfaction from the same dollar gain.

b) Individuals are risk LOVERS with respect to INCREASES in wealth.

c) Individuals are risk LOVERS with respect to DECREASES in wealth.

d) Both a) and b).

e) Both a) and c).

21) Great grandfather Marion told his children to NEVER sell an investment for less than what you paid for it. His children gave their children this advice, and these grandchildren have in turn given their children the same advice. Great grandson Stuart thinks that this advice is a type of behaviour bias known as ____________.

a) Conservatism

b) Mental accounting (anchoring)

c) Representativeness

d) Overconfidence

e) None of the above

Answer 1

Answer 20:- Option (b)- Individuals are risk LOVERS with respect to INCREASES in wealth.

( Explanation- The prospect theory says investors will choose the product that offers the most perceived gains. And they will seek the risks when they are certain of perceived gains. Investors chose perceived gains because losses cause a greater emotional impact.

In case of Option (a)- It is wrong to say that a dollar loss is less painful than the satisfaction from the same dollar gain because according to prospect theory, a dollar loss is 2 1/2 times as painful as a dollar gain is pleasurable.

In case of Option (c) - It is wrong to say that  Individuals are risk lovers with respect to decreases in wealth because instead they are risk averse and do not want to undertake the risk if chance of losing is involved.

In case of Option (d) & (e)- Both can't be correct as it includes the combination of Option (a) and (c) in them and they are themselves incorrect.

Answer 21:- Option (a)- Conservatism

( Explanation- Under conservatism bias, an investor clings to a view or a forecast, behaving too inflexibly when presented with new information. Hence, in this case the advice given to coming generations caused them to cling to the view of never selling the investment for less than what one paid for it and any other view or information will not be considered by the individual who is having conservatism bias.

In case of Option (b), (c), (d) & (e)- they represent other kinds of biases and not related to the given situation)