If you give a person a choice between a very high probability of making a little money and a very low probability of making a lot of money, what do you think they will choose?
You will realize that people make decisions unconsciously and that is what Maurice Allais demonstrated with his experiments in the 1950's. Allais, a French economist and physicist, posed in his book "The Behavior of Rational Man in the Face of Risk", a choice problem to show the inconsistency of the expected utility theory.
Expected utility, or expected utility theory, is a theory that describes a rational choice model with uncertain outcomes. In this way, the theory allows us to classify outcomes in terms of utility, and to represent them by means of the function that bears its name: the utility function. Thus, the outcome chosen is the one with the highest utility.
What is the Allais paradox?
This paradox shows, through the results of two experiments, how people make decisions unconsciously. In the studies that were done, the result was that they preferred a lower but safer return in the first experiment and a higher but more improbable return in the second.
There are examples where, in general, if you give a person a choice between a very high probability of making little money and a very low probability of making a lot of money they will choose the first option. However, if you give them a choice of how much they would sell the two options for, the vast majority put a higher price on the second option.
Do you want to know what Allais' two experiments were based on, are you interested in the different theories that have been published on behavioral finance? All these topics and more in our Psychotrading course of the Financial Markets training. Ask us without obligation: email@example.com