Dominique van Schagen Judgment and Decision Making
Thaler, R. (1999). Mental accounting matters. Journal of Behavioral Decision Making
Mental accounting is the set of cognitive operations used by individuals and households to
organize, evaluate, and keep track of financial activities.
Three components of mental accounting that receive the most attention:
- How outcomes are perceived and experienced, and how decisions are made and
evaluated
- Assignment of activities to specific accounts
- The frequency with which accounts are evaluated and ‘choice bracketing’
The value function of mental accounting has three important features:
1. The value function is defined over gains and losses relative to some reference point
2. Both the gain (concave) and loss (convex) functions display diminishing sensitivity
3. Loss aversion: losing $100 hurts more than gaining $100 gains pleasure -> v(x) < - v(-x)
A mental account is an outcome frame which specifies
- The set of elementary outcomes that are evaluated jointly and the manner in which
they are combined
- A reference outcome that is considered neutral or normal
So, a mental account is a frame for evaluation.
Three ways that outcomes might be framed:
- Minimal account: examining only differences between 2 options, leaving out the
similarities
- Topical account: relates consequences of possible choices to a reference level
- Comprehensive account: incorporates all other factors (wealth, future earnings, etc).
This form is the most generally used according to economic theory.
Principles of hedonic framing (evaluating joint outcomes to maximize utility):
1. Segregate gains (because gain function is concave)
2. Integrate losses (because loss function is convex)
3. Integrate smaller losses with larger gains (to offset loss aversion)
4. Segregate small gains from larger losses (because gain function is steepest at origin,
the utility of a small gain can exceed utility of slightly reducing a large loss)
Hedonic editing rule: v(x&y) = Max[v(x+y), v(x) + v(y)]
Consumers get two kinds of utility from a purchase:
- Acquisition utility: a measure of the value of the good obtained relative to its price.
The value the consumer would place on receiving it as gift, minus the price paid.
- Transaction utility: measures the perceived value of a ‘deal’. Difference between
amount paid and the ‘reference price’ (= regular price consumer expects to pay)
Credit cards are handy because:
- The payment is later than the purchase
- The payment is separated from the purchase
, Dominique van Schagen Judgment and Decision Making
Money is commonly labeled at three levels:
- Expenditures are grouped into budgets (food, housing)
- Wealth is allocated into accounts (checking, pension)
- Income is divided into categories (regular, windfall)
Dividing it into budget categories serves two purposes:
- Budget process can facilitate making rational trade-offs between competing uses for
funds
- The system can act as a self-control device
Tracking process by which expenses are tracked against budgets can be divided into two
stages:
- Expenses must first be noted (booked; attention and memory cognitive system (CS))
- Then assigned into their proper accounts (posted similarity judgments and
categorization CS)
Violations of fungibility:
- One budget has been spent up to its limit while other accounts have unspent funds
remaining
- Some budgets have been intentionally set ‘too low’ in order to help deal with self-
control problems
- Source of income
A loss hurts less if it can be combined with a larger gain
Myopic loss aversion: when investors take a view of their investments that is strongly focused
on the short term, leading them to react too negatively to recent losses, which may be at the
expense of long-term benefits
Narrow framing: projects are evaluated one at a time, rather than as part of overall portfolio.
Diversification bias: when people have to choose simultaneously, they tend to diversify than
when they pick separately.
Thaler, R. (1999). Mental accounting matters. Journal of Behavioral Decision Making
Mental accounting is the set of cognitive operations used by individuals and households to
organize, evaluate, and keep track of financial activities.
Three components of mental accounting that receive the most attention:
- How outcomes are perceived and experienced, and how decisions are made and
evaluated
- Assignment of activities to specific accounts
- The frequency with which accounts are evaluated and ‘choice bracketing’
The value function of mental accounting has three important features:
1. The value function is defined over gains and losses relative to some reference point
2. Both the gain (concave) and loss (convex) functions display diminishing sensitivity
3. Loss aversion: losing $100 hurts more than gaining $100 gains pleasure -> v(x) < - v(-x)
A mental account is an outcome frame which specifies
- The set of elementary outcomes that are evaluated jointly and the manner in which
they are combined
- A reference outcome that is considered neutral or normal
So, a mental account is a frame for evaluation.
Three ways that outcomes might be framed:
- Minimal account: examining only differences between 2 options, leaving out the
similarities
- Topical account: relates consequences of possible choices to a reference level
- Comprehensive account: incorporates all other factors (wealth, future earnings, etc).
This form is the most generally used according to economic theory.
Principles of hedonic framing (evaluating joint outcomes to maximize utility):
1. Segregate gains (because gain function is concave)
2. Integrate losses (because loss function is convex)
3. Integrate smaller losses with larger gains (to offset loss aversion)
4. Segregate small gains from larger losses (because gain function is steepest at origin,
the utility of a small gain can exceed utility of slightly reducing a large loss)
Hedonic editing rule: v(x&y) = Max[v(x+y), v(x) + v(y)]
Consumers get two kinds of utility from a purchase:
- Acquisition utility: a measure of the value of the good obtained relative to its price.
The value the consumer would place on receiving it as gift, minus the price paid.
- Transaction utility: measures the perceived value of a ‘deal’. Difference between
amount paid and the ‘reference price’ (= regular price consumer expects to pay)
Credit cards are handy because:
- The payment is later than the purchase
- The payment is separated from the purchase
, Dominique van Schagen Judgment and Decision Making
Money is commonly labeled at three levels:
- Expenditures are grouped into budgets (food, housing)
- Wealth is allocated into accounts (checking, pension)
- Income is divided into categories (regular, windfall)
Dividing it into budget categories serves two purposes:
- Budget process can facilitate making rational trade-offs between competing uses for
funds
- The system can act as a self-control device
Tracking process by which expenses are tracked against budgets can be divided into two
stages:
- Expenses must first be noted (booked; attention and memory cognitive system (CS))
- Then assigned into their proper accounts (posted similarity judgments and
categorization CS)
Violations of fungibility:
- One budget has been spent up to its limit while other accounts have unspent funds
remaining
- Some budgets have been intentionally set ‘too low’ in order to help deal with self-
control problems
- Source of income
A loss hurts less if it can be combined with a larger gain
Myopic loss aversion: when investors take a view of their investments that is strongly focused
on the short term, leading them to react too negatively to recent losses, which may be at the
expense of long-term benefits
Narrow framing: projects are evaluated one at a time, rather than as part of overall portfolio.
Diversification bias: when people have to choose simultaneously, they tend to diversify than
when they pick separately.
