CFA CFA Level 3 CFAI 2013 AM Q3a – Behavioral utility

CFAI 2013 AM Q3a – Behavioral utility

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      Can someone explain why Friedman-Savage utility function and Prospect theory seem to contradict each other? Pg 18, Vol 2, Prospect Theory says concave for gains (implying risk aversion), convex for losses (risk-seeking) and Q3 on the 2013 exam says the opposite according to Friedman-Savage…risk seeking (convex) for gains and risk-averse (concave) for losses. Is it semantics and one is taking about avoiding gains or losses? I’m confused! Thank you, thank you!

    • Avatar of RaviVoodaRaviVooda
        • CFA Level 3

        @color3‌ In prospect theory, one side is on gain, the other side is about losses. It say people sell it quick when they have gains and sell it late when in losses because of loss aversion. In gains curve is concave and in losses it is convex.

        Friedman-savage utility says that after sometime earning good amount, man will take risk all of sudden and then the curve becomes convex, later after earning a lot he will again become defensive making the curve concave again. The points at which nature changes is called inflection points. So when conservative people it is like buying insurance policy and when risky they act like buying lottery ticket.

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