research@hec - Issue#3 - (Page VII)

Loss Aversion and Decision-Making Prospect Theory, a theory that describes decisions between alternatives that involve risk, was developed by Daniel Kahneman. He was awarded the 2002 Nobel Prize in Economics for his work in Prospect Theory, which revealed an important element of behaviour under risk: the phenomenon known as loss aversion. This refers to the tendency for people strongly to prefer avoiding losses than acquiring gains. Loss aversion explains many empirical observations, especially in the financial markets. Mohammed Abdellaoui is leading a research programme that aims, among other things, to measure this phenomenon, with the specific aim of improving decision-making. Can decision-making under risk be improved without taking into account the difference in people's sensitivity to gains and losses? Mohammed Abdellaoui does not believe this is possible, and proposes a model for measuring loss aversion under Prospect Theory. Based on an interview with Mohammed Abdellaoui and his article “Loss Aversion Under Prospect Theory: A Parameter-Free Measurement”1 (Management Science, October 2007). M FUNDAMENTAL QUESTIONS RELATING TO DECISION UNDER UNCERTAINTY Mohammed Abdellaoui's work on decision under uncertainty focuses on three key questions: how can rational decisions be made under uncertainty (normative considerations)? How do individuals and organizations make choices in situations where they have to decide between alternatives with uncertain outcomes (descriptive considerations)? How can a decision-maker who has to choose between alternatives with uncertain outcomes be helped to make the right decision (prescriptive considerations)? The recent appointment of a research team to study Behavioral Decision Making in the GREGHEC research laboratory aims to answer these questions through MEASURING PREFERENCES: A PREREQUISITE FOR IMPROVING DECISION-MAKING Decision Analysis, a discipline that uses a standard model of rational choices in risk situations to improve decision-making2, was developed by Howard Raiffa in 1968. The main idea behind Decision Analysis is to reveal a decision maker's preferences when faced with simple choices, and use them as a basis for determining how they're likely to react in more complex situations. A decision maker's preferences are revealed through the subjective values they attribute to the consequences of their decisions (utility functions) and their beliefs about the likelihood of the uncertain events they're dealing with (subjective probabilities). Several laboratory and field studies have shown, however, that it's impossible to ignore certain tendencies when measuring individual preferences (in simple risk situations). Prospect Theory allows us to measure preferences that take these tendencies into account. Moreover, the possibility of measuring loss aversion enables us to take into account decision makers' trade-offs between gains and losses more explicitly. research conducted by HEC. The business school provides an ideal environment for this kind of research, which is why questions relating to the improvement of decision-making are given priority in the HEC team's research programmes. CAREER Mohammed Abdellaoui holds a PhD in economics, mathematics, and econometrics from the University of AixMarseille III. He joined the CNRS (French National Scientific Research Centre) in 1992 and became director of research in 2001. In 2007, he joined HEC Paris as researcher in the GREGHEC research laboratory and associate professor of decision sciences. A specialist in risk and time perception, he has published many articles (in journals such as Econometrica, Management Science, and the Journal of Econometrics). He has co-published works on the recent progress made in modelling decision under uncertainty, and is editor-in-chief of the international journal Theory and Decision. June-July 2008 • research@hec VII http://www.hec.fr/hec/eng/professeurs_recherche/r_index.html

Table of Contents for the Digital Edition of research@hec - Issue#3

Cover & Contents
The Role of Research Chairs at HEC
Radical Innovations in Major Companies, by Sihem Jouini
How to Develop Profitable Services, by Wolfgang Ulaga
Loss Aversion and Decision-Making, by Mohammed Abdellaoui

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