Economics of Cybersecurity Prospect Theory Sophie Van Der Zee The - PowerPoint PPT Presentation

Economics of Cybersecurity Prospect Theory Sophie Van Der Zee The Computer Lab, University of Cambridge

Decision-making  People constantly make decisions involving different levels of risk and uncertainty  Psychologists and economists have tried to capture human decision-making under risk in theoretical models to explain and predict people’s behavior

Expected utility theory (1)  Daniel Bernoulli, 1738  Dominant theory until the mid 20th century  Three important concepts:  Utility (psychological value)  Wealth (current state)  Rational choice model

Expected utility theory (2) Utility  Utility does not increase proportionately with the amount of money  Example:  The first pound extra is worth more than the 10 th or the 100 th  A gamble should be assessed by its expected utility, not by expected absolute value

Expected utility theory (3) Wealth  Utility is dependent on the current state of wealth  Example:  £10 is worth more to someone who only has £10 than to someone who has £100, a £1000 or £100,000  Wealth is included when calculating the best option

Expected utility theory (4) Model of rational choice  The utility of potential outcomes is weighted by the probability of its occurrence  Example:  60% chance of + £10 = £ 6  50% chance of + £10 = £ 5  People are expected to choose the best option

Expected utility theory (4) Model of rational choice  The utility of potential outcomes is weighted by the probability of its occurrence  Example:  60% chance of + £10 = £ 6  50% chance of + £10 = £ 5  People are expected to choose the best option

Issues with expected utility theory  Although we could make decisions based on rational cost- benefit analyses, we often don’t for two reasons: 1. People have an irrational tendency to be less willing to gamble with profits than with losses  prospect theory 2. We use mental shortcuts instead of calculating all possible options  heuristics

Prospect theory (1)  Kahneman & Tversky (1979)  People do not always make rational decisions because they value gains and losses differently  Centred around loss aversion  “A bird in the hand is worth two in the bush”

Prospect theory (2) We experience stronger emotions during loss than during gain  Loss aversion

Prospect theory (3) People are risk-seeking when faced with potential loss, while they are risk averse and prefer certainty for gains

Example (1) – “Asian Flu”  There are 2 programs to battle a disease  In program A, 200 people will be saved  In program B, there is a 1/3 probability that 600 people will be saved, and a 2/3 probability that no one will be saved

Example (1) – Expected utility theory  There are 2 programs to battle a disease  In program A, 200 people will be saved  In program B, there is a 1/3 probability that 600 people will be saved, and a 2/3 probability that no one will be saved Absolute outcome is the same

Example (1) – Prospect theory  There are 2 programs to battle a disease  In program A, 200 people will be saved  In program B, there is a 1/3 probability that 600 people will be saved, and a 2/3 probability that no one will be saved  Risk averse in gain scenario

Example (2)  There are 2 programs to battle a disease  In program C, 400 people will die  In program D, there is a 1/3 probability that no one will die, and a 2/3 probability that 600 people will die

Example (2) – Expected utility theory  There are 2 programs to battle a disease  In program C, 400 people will die  In program D, there is a 1/3 probability that no one will die, and a 2/3 probability that 600 people will die Absolute outcome is the same!

Example (2) – Prospect theory  There are 2 programs to battle a disease  In program C, 400 people will die  In program D, there is a 1/3 probability that no one will die, and a 2/3 probability that 600 people will die  Risk seeking when facing potential loss

Prospect theory (4)  People do not always make a rational choice of the best option  Experiments show that people deviate from rationality in a consistent, predictable manner  One reason is that they value gains and losses differently  “It ain’t what you say, but the way that you say it”

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