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A snapshot of the summary  Judgment & Decision Making in Accounting

1 Week 1  Normative decision making

What are normative models?How people
should be making judgments and decisions. 
What are prescriptive models?Practical suggestions on designing judgment and decisionmaking processes based on normative and descriptive models.

System 1 and System 2 thinking has the central notion:
accessibility . What is meant with that and what are thedeterminants ofaccessibility ? How easily something comes to mind.
 Perceptions and intuitions come to mind effortlessly.Determinants :
 Perceptualsalience
Surprisingness
 Familiarity
 When things ... are associated with emotion
 are associated with potential losses
 are in line with our current 'mindset'

What does Baron (2004) state about normative models of decision making?
 Any normative model needs to start from the simple idea that some outcomes are better than others.
 No claim about absolute truth, but 'truth relative to assumptions'
 Normative models are through the 'imposition of an analytic scheme': The scheme is designed to fit the basic facts about who we are, but not necessarily to fit our intuitions.
 Any normative model needs to start from the simple idea that some outcomes are better than others.

What is the Bayes theorem?The theory provides a normative model for how we should update our beliefs (personal probabilities) in the presence of new information
It tells us:
P(AB)  the probability of A given B
When we know:
P(BA)  the probability of B given A,
P(A)  the probability of A,
P(B) and the probability of B. 
Give the normative decision making: summary
 List all possible courses of action
 Choose the one with the highest expected utility
 If new information becomes available: update your beliefs using Bayes' theorem and repeat...
 List all possible courses of action

2 Week 2  How we attach value to things: the role of risk and uncertainty

What is the Ellsberg paradox?This is a paradox of choice in which people's decisions produce inconsistencies with subjective expected utility theory.

How do we attach value according to risk
aversion and ambiguity aversion ? Risk aversion: valuing a sure thing higher than a risky thing, even though the expected monetary value of the two is the same.
 Prospect theory
 The certainty effect = the tendency of people to feel disproportionately better about outcomes that are certain compared to outcomes that are probable or possible.
 The possibility effect (think of the irrational decision to buy a lottery ticket): highly unlikely outcomes are given more weight than their probability justifies.
 Ambiguity aversion: we are willing to pay less for a vague choice than for a clear choice.
 The Elsberg paradox
 Risk vs ambiguity: known vs unknown probabilities)

How do we attach value according to loss aversion?Loss aversion: losses weigh heavier than same size gains
 The endowment effect: we attach higher value to thing than we own than to that we do not own.
 Related phenomenon: the IKEA effect  we place disproportionate value on things that we created ourselves.
 The Zero Price effect: the difference between no cost and very small cost has a disproportionate impact.

How do we attach value according to framing?Framing: presenting something as a gain or a loss. More generally, the term framing is often used to describe the way in which a choice is presented.
 The Tom Sawyer effect: framing an unpleasant task as a privilege or unique opportunity.
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