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Prospect Theory as Efficient Perceptual Distortion

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  • Michael Woodford

Abstract

The paper proposes a theory of efficient perceptual distortions, in which the statistical relation between subjective perceptions and the objective state minimizes the error of the state estimate, subject to a constraint on information processing capacity. The theory is shown to account for observed limits to the accuracy of visual perception, and then postulated to apply to perception of options in economic choice situations as well. When applied to choice between lotteries, it implies reference-dependent valuations, and predicts both risk-aversion with respect to gains and risk-seeking with respect to losses, as in the prospect theory of Kahneman and Tversky (1979).

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.102.3.41
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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 102 (2012)
Issue (Month): 3 (May)
Pages: 41-46

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Handle: RePEc:aea:aecrev:v:102:y:2012:i:3:p:41-46

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  1. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  2. Heath, Timothy B & Chatterjee, Subimal, 1995. " Asymmetric Decoy Effects on Lower-Quality versus Higher-Quality Brands: Meta-analytic and Experimental Evidence," Journal of Consumer Research, University of Chicago Press, vol. 22(3), pages 268-84, December.
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