Read the summary and the most important questions on Judgment & Decision Making in Accounting

• 1 Week 1 - Normative decision making

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• What are normative models?

  How people should be making judgments and decisions.

• What are prescriptive models?

  Practical suggestions on designing judgment and decision-making 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 the determinants of accessibility?

  - How easily something comes to mind.
  - Perceptions and intuitions come to mind effortlessly. 
  
  Determinants:
  - Perceptual salience    
  - 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.
    

• 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(A|B) - the probability of A given B 
  
  When we know:
  P(B|A) - 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...

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

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• 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.