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Non-Monotonicity of the Tversky-Kahneman Probability-Weighting Function: A Cautionary Note

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Author Info
Jonathan Ingersoll
Abstract

"Cumulative Prospect Theory has gained a great deal of support as an alternative to Expected Utility Theory as it accounts for a number of anomalies in the observed behavior of economic agents. Expected Utility Theory uses a utility function and subjective or objective probabilities to compare risky prospects. Cumulative Prospect Theory alters both of these aspects. The concave utility function is replaced by a loss-averse utility function and probabilities are replaced by decision weights. The latter are determined with a weighting function applied to the cumulative probability of the outcomes. Several different probability weighting functions have been suggested. The two most popular are the original proposal of Tversky and Kahneman and the compound-invariant form proposed by Prelec. This note shows that the Tversky-Kahneman probability weighting function is not increasing for all parameter values and therefore can assign negative decision weights to some outcomes. This in turn implies that Cumulative Prospect Theory could make choices not consistent with first-order stochastic dominance". Copyright (c) 2008 The Author Journal compilation (c) 2008 Blackwell Publishing Ltd.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1468-036X.2007.00439.x
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Article provided by Blackwell Publishing Ltd in its journal European Financial Management.

Volume (Year): 14 (2008)
Issue (Month): 3 ()
Pages: 385-390
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Handle: RePEc:bla:eufman:v:14:y:2008:i:3:p:385-390

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  1. Santos-Pinto, Luís & Astebro, Thomas & Mata, José, 2009. "Preference for Skew in Lotteries: Evidence from the Laboratory," MPRA Paper 17165, University Library of Munich, Germany. [Downloadable!]
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