Raymond Dacey

A Detailed Prospect Theory Explanation of the Disposition Effect

The disposition effect has been characterized in various ways: the “effect, whereby investors are anxious to sell their winners, but reluctant to sell their losers” (Shefrin [2005], pp. 419); “the tendency to hold losers too long and sell winners too soon” (Odean [1998], pp. 1775) and the effect, whereby investors “sell winners more readily than losers” (Odean [1998], pp. 1779). The most discernable aspect of these characterizations is their imprecision, particularly with regard to time. In what follows, we provide a detailed explanation of the disposition effect based on a straightforward application of prospect theory (Kahneman and Tversky [1992]; Kahneman and Tversky [1979, 2000]). The analysis begins with the traditional account of the disposition effect (Shefrin and Statman [1985]) and provides precise time-independent concepts that replace “sell too soon” and “hold too long.” The analysis shows when the prospect theory explanation of the disposition effect requires only the valuation function and when the explanation requires both the valuation function and the probability weighting function.

Perception of randomness and predicting uncertain events

Using randomly generated sequences of binary events we asked participants to make predictions about the next event. It turned out that while predicting uncertain events, people do not behave unsystematically. Our research identifies four types of relatively consistent strategies for predicting uncertain binary events: a strategy immune to short-run sequential dependencies consisting of the persistent prediction of long-run majority events, hereafter called the long-run momentum strategy; a strategy immune to short-run sequential dependencies consisting of the persistent prediction of long-run minority events, called the long-run contrarian strategy; a strategy sensitive to short-run sequential dependencies consisting of the prediction of short-run majority events, called the short-run momentum strategy; and a strategy sensitive to short-run sequential dependencies consisting of the prediction of short-run minority events, called the short-run contrarian strategy. When the character of events remains unknown, the most common strategy is the short-run momentum strategy. With the increase of a perceived randomness of the situation, people tend more often to use the short-run contrarian strategy. People differ in their general beliefs about the continuation or reversal of a trend in various natural and social processes. Trend believers, when facing sequences of binary events commonly perceived as random, tend to use momentum strategies, whereas those who believe in the trends reversal tend to use contrarian strategies.

Traditional Decision Analysis and the Poliheuristic Theory of Foreign Policy Decision Making

The poliheuristic theory of foreign policy decision making posits a two-stage process wherein the decision maker first employs a noncompensatory decision rule to eliminate politically unacceptable alternatives and then employs a (perhaps) traditional decision procedure to select from the remaining set of acceptable alternatives. Ageneral decision analysis is used to provide a structured account of the elimination process of the first stage of the poliheuristic theory by displaying a noncompensatory decision rule for eliminating unacceptable policy alternatives. The results show how general decision analysis can be used to specify when an alternative is unacceptable to a political decision maker who is sensitive to public opinion.

The optimality of tit‐for‐tat

The paper examines the performance of tit‐for‐tat in iterated plays of prisoners’ dilemma and chicken. In particular, the paper examines, via computer simulations, a space of surrogate Axelrod‐type tournaments over these games. The surrogate tournaments are specified in terms of characteristics of strategies similar to those Axelrod identifies as fundamental. The paper shows that the zones of optimality for tit‐for‐tat in tournament play of both prisoners’ dilemma and chicken remarkably constrained, but that tit‐for‐tat generally does well relative to other strategies. Furthermore, our results show that the success of tit‐for‐tat is sensitive to the number of players and the assignment of payoff values.

Sequential Analysis of Deterrence Games with a Declining Status Quo

The model developed in this paper provides a formal prospect theory account of Challengers behavior in the traditional deterrence game played under sequential decision analysis. The model is used to analyze two basic claims commonly made in the international relations literature regarding the importation of prospect theory into the analysis of crisis games. These claims pertain to Challengers behavior when the valuation of the status quo is positive and Challengers behavior when the valuation of the status quo is negative. We model the traditional deterrence game between Challenger and Defender as a one-sided incomplete information game where Challenger is uncertain about Defenders preference ordering. We examine the behavior of Challenger under the condition that the status quo is declining, using a von Neumann—Morgenstern decision rule as specified by expected utility theory, and a Kahneman—Tverksy decision rule as specified by prospect theory. The formal results show that these claims do not hold unconditionally and must be stated more precisely. Furthermore, there exist conditions under which the claims are false. We show that in addition to specifying the valuation of the status quo and the value of the probability of loss, as per the claims, a fuller understanding of Challengers behavior also requires a specification of Challengers valuation of the status quo vis-à-vis the valuations of other major payoffs in the game. In so doing, we capture many of the details relevant to a more complete analysis of Challengers behavior in the deterrence game.

Risk Attitude, Punishment, and the Intifada

The Israelis occupied the Gaza Strip and the West Bank for approximately twenty years without facing an uprising. This state of affairs ended, surprising both the Israelis and the PLO, in December 1987 with the beginning of the Intifada. Various authors conclude that the Israeli occupation policy caused the Intifada (Peretz 1990; Nassar and Heacock 1990; Siniora 1988; U.S. Department of State 1989). This paper takes exception with the foregoing view. This paper offers a rational actor explanation of why the occupation policy was adopted, why the occupation policy deterred an uprising for twenty years, and why the change from the occupation policy to the Iron Fist policy caused the Intifada. In particular, the key to the explanation is the change, which came with the Iron Fist policy, in the likelihood of punishing non-participants. This change, and not the occupation policy, made participation in acts of insurrection the preferred option.

Crime control and harassment of the innocent

Crime control through law enforcement is generally considered to be a two-part process of apprehending and incapacitating or rehabilitating the guilty, and deterring the innocent from crime by the threat of punishment. The analysis presented here shows that the protection of the innocent from harassment–detention, arrest, punishment, and other intrusions by the criminal justice system–is important in deterring crime. Specifically, the analysis shows that deterrence from crime is weakened and then lost for a rational individual who holds the majority attitude toward risk, if the levels of rightful punishment and wrongful harassment are increased, as in a war on crime, and the likelihoods of wrongful and rightful punishment are reasonably close. The analysis is employed to show how the perceived likelihood of harassment may be a contributing factor to the disproportionately high representation of minority groups in the U.S. prison system.

Inducing fair trade out of hegemonic trade

This paper provides a model of the transition from hegemonic trade to contemporary (or fair) trade. Hegemonic trade is an instance of the two player game called Bully (Poundstone 1992) and Called Bluff (Snyder and Diesing 1977); contemporary trade is an instance of Prisoners Dilemma (Krugman and Obstfeld 1991). In this paper, I show that a nation under the thumb of a hegemon, called the conciliatory nation, can induce fair trade. Further, I show that to induce fair trade, the conciliatory nation must not be timied.

Sequential Decision Analysis of the Traditional Deterrence Game

We examine the traditional deterrence game between Challenger and Defender. We treat two variations of the game – the complete information game and the one-sided information game where the first mover, Challenger, is the uncertain player. We employ sequential decision theory to analyze the game of incomplete information. The analysis is basic in that we employ a simplifying assumption, specifically that Challenger’s valuation of the status quo is fixed at zero. We examine the behavior of Challenger using both a von-Neumann-Morgenstern decision rule and a Kahneman-Tversky decision rule. The formal results show that given the right combination of outcome valuations and probability values and weightings, Challenger can make choices under the von Neumann-Morgenstern decision rule that are reversed from those made under the Kahneman-Tversky decision rule. We then relate these reversals to the concept of misperception found in the International Relations and Peace Science literatures. Finally, we comment on extensions of the ensuing analysis.

An interrogative account of the dialectical inquiring system based upon the economic theory of information

Consider an individual Z who faces a practical (i.e. shopkeeper) decision problem A = (O, O) with state-space O and act-space O. To resolve zl, individual Z must determine (1) the consequences of performing the alternative acts in the various states of nature, (2) the valuations to be assigned to those consequences, and (3) the probabilities to be assigned to the states of nature. That is, Z must determine (1) an outcome mapping pz : Ox O ~ ~ , (2) a utility function tXz : • ~ Re 1, and (3) a probability distribution Pz : O ~ [0, 1]. To make these determinations, Z requires a view of the world, a conceptualization of reality that permits (1) the prediction of future states of the world, (2) an analysis of risk preference over those states of the world, and (3) the formulation of partial beliefs about the states of nature. The acquisition of such a world-view is the object of study. A world-view is acquired via inquiry. The present study is restricted to dialectical inquiry, and expands upon Churchmans account of the dialectical inquirer [3] by incorporating some basic concepts from the economics of information [14, 15]. The result is a model of rational questioning and answering that incorporates the basic concepts form the logic of questions and answers [1,2,5,7, 10, 11] and provides a specification of a synthesis process that leads to a resolution of the problem A. The paper proceeds as follows. Section I reviews Churchmans account of the dialectical inquiring system and proposes some minor revisions. Section II provides a logic of questions and answers. Section III considers the motives of the inquirer and presents a procedure for selecting questions. Section IV considers motives for the respondents and presents the procedures for selecting answers. Section V presents