Individual Decisions Under Conditions Of Uncertainty--The Challenge From Behavioral Economics

One of the most intriguing areas of research in finance is that which examines and seeks to explain how and why individuals make decisions. This research is aimed at predicting accurately decisions that will be made given certain conditions and circumstances. The most commonly accepted model of rational choice today is the theory of utility of wealth developed by Von Neuman and Morgenstern (1953).Questions have arisen recently, however, concerning the completeness of this theory. These questions have given impetus to competing theories that attempt to explain individual behavior under conditions of uncertainty. Allais paradox challenges expected utility theory first. Thereafter, the discovery of "preference reversal" phenomenon based on preference induction becomes a real beat on it.So, Kahneman and Tversky give a new explaination about how to make decisions under conditions of uncertainty,as to the explaination of behavioral economics. Accordingly the prospect theory which is a effective substitute of expected utility theory comes out. Kahneman and Tversky realized the fact that the expected utility theory model did not fully describe the manner in which individuals make decisions in risky situations and that therefore, there were instances in which a decision-maker's choice could not be predicted. For example, they point out that expected utility theory does not explain the manner in which framing can change the decision of the individual, nor does it explain why individuals exhibit risk-seeking behavior in some instances and risk-averse behavior in others.This paper designed, in essence, as a substitute for expected utility theory present exactly that how people make decisions under conditions of uncertainty. Section I begins with the produce of expected utility theory, prove that the assumption of expected utility theory is to the substitution of the early risk -bearing theory,Make it produce tentatively through the proposition and settlement of the St.Petersburg paradox.And then describes particularly the model of expected utility theory.Section II brings forward some objections about it, and presents "Allais paradox" and "preference reversal" phenomenon separatedly. "Allais paradox " should be announced in fact, a lot of expected utility set up in the independent assumption, Especially the models on the basis of pursueing expected utility to maximize have all neglected the impact on probability distribution set up by psychological factor,Therefore it is not geared to actual circumstances . Subsequently, the phenomenon of preference reversal has formed a real impact to the utility theory,it is a deadliness challenge to the transferability which is one of the economics logos axiom.Section III points out the lack of expected utility theory which on the foundation of axiom-hypothesis, it has put forward the query to the coherence of space and time in the system of static axiom. And then advances the objections of Kahneman and Tversky, think that people made decision that it is very difficult to accomplish complete reason, a lot of assumptions of the utility theory are not tenable. Point out at last the defect of utility maximizes model. There are three points mainly: 1. Recollected utility and experienced utility are inconsistent. 2. The weight of the result can't be assigned correctly to make policy. 3. Decision utility and experienced utility are inconsistent. Section IV goes into particulars on the utility theory. It introduces the unreasonable and risk partial of people, such as: 1. Certainty effect, under specific circumstances,underestimates some results with possibility in people's utility function.Over-evaluate the deterministic result correspondingly. 2. Reflection effect,according to reflecting effect principle, the choice to the profit prospect of people is equivalent to the choice which loses the prospect, the choices in lost prospect is like a mirror image of the choices in profit prospect. 3. Isolation effect, when analysing and assessing different prospect which is waiti...