Prospect Theory editing process

CFA Level III Portfolio Management
#1

The last operation of Prospect Theory editing process:

Detection of Dominance: Outcomes that are strictly dominated are scanned and rejected without further evaluation.

Why outcomes that are strictly dominated have to be removed from further evaluation?

#2

If investment A is _ never _ better than investment B, would you consider investment A?

#3

^ perfect. Thanks, for the great explanation!

#4

Dominance means the “worst”, not the “best”?

#5

Dominance, noun

Dominated, adjective

Be careful with the reading.

#6

From Schweser: "Detection of dominance would discard from consideration any proposal that is clearly dominated. The previous 50/50 chance of $500 or $700 dominates an equal chance of $400 or $600 in every regard: higher average, higher minimum, and higher maximum."

So, the dominated best outcome has been rejected, not the worst.

#7

So you reject the latter.

You’re rejecting the 50/50 chance of $400/$600. That’s a worse outcome than a 50/50 chance of $500/$700, not a better outcome.

#8

Thank you!

#9

My pleasure.