Advanced Search
MyIDEAS: Login to save this article or follow this journal

Prospect theory and utility theory: Temporary versus permanent attitude toward risk

Contents:

Author Info

  • Levy, Haim
  • Wiener, Zvi

Abstract

Prospect theory (PT), which relies on subjects’ behavior as observed in laboratory experiments, contradicts the behavior predicted by the Expected Utility (EU) paradigm. Having wealth of $100,000 or having wealth of $90,000 and winning $10,000 in a lottery is the same by EU paradigm but not the same by Markowitz (1952) and by PT (1979) which emphasizes the importance of change of wealth rather than total wealth on welfare. In this study, we resolve this contradiction by introducing the concept of temporary attitude toward risk (TATR) and permanent attitude toward risk (PATR). Using these concepts, we build a model that merges both the PT and the EU paradigms. The TATR and PATR concepts explain recent experimental findings and the observed stock price overreaction. We show that a positive risk premium with decreasing absolute risk aversion (DARA) can be consistent with the S-shaped value function used in PT.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.sciencedirect.com/science/article/pii/S0148619513000118
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Bibliographic Info

Article provided by Elsevier in its journal Journal of Economics and Business.

Volume (Year): 68 (2013)
Issue (Month): C ()
Pages: 1-23

as in new window
Handle: RePEc:eee:jebusi:v:68:y:2013:i:c:p:1-23

Contact details of provider:
Web page: http://www.elsevier.com/locate/jeconbus

Related research

Keywords: Utility theory; Prospect theory; Value function; Risk attitude;

Find related papers by JEL classification:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. De Bondt, Werner F M & Thaler, Richard, 1985. " Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
  2. Shefrin, Hersh & Statman, Meir, 1985. " The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence," Journal of Finance, American Finance Association, vol. 40(3), pages 777-90, July.
  3. Samuelson, William & Zeckhauser, Richard, 1988. " Status Quo Bias in Decision Making," Journal of Risk and Uncertainty, Springer, vol. 1(1), pages 7-59, March.
  4. Botond Koszegi & Matthew Rabin, 2006. "Reference-Dependent Risk Attitudes," Levine's Bibliography 122247000000001267, UCLA Department of Economics.
  5. Conrad, Jennifer & Kaul, Gautam, 1989. "Mean Reversion in Short-Horizon Expected Returns," Review of Financial Studies, Society for Financial Studies, vol. 2(2), pages 225-40.
  6. Levy, Haim & Paroush, Jacob, 1974. "Toward multivariate efficiency criteria," Journal of Economic Theory, Elsevier, vol. 7(2), pages 129-142, February.
  7. Hanoch, G & Levy, Haim, 1969. "The Efficiency Analysis of Choices Involving Risk," Review of Economic Studies, Wiley Blackwell, vol. 36(107), pages 335-46, July.
  8. Shefrin, Hersh & Statman, Meir, 2000. "Behavioral Portfolio Theory," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(02), pages 127-151, June.
  9. Quiggin, John, 1982. "A theory of anticipated utility," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 323-343, December.
  10. Handa, Jagdish, 1977. "Risk, Probabilities, and a New Theory of Cardinal Utility," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 97-122, February.
  11. Levhari, David & Paroush, Jacob & Peleg, Bezalel, 1975. "Efficiency Analysis for Multivariate Distributions," Review of Economic Studies, Wiley Blackwell, vol. 42(1), pages 87-91, January.
  12. Haim Levy, 1992. "Stochastic Dominance and Expected Utility: Survey and Analysis," Management Science, INFORMS, vol. 38(4), pages 555-593, April.
  13. Chris Starmer, 2000. "Developments in Non-expected Utility Theory: The Hunt for a Descriptive Theory of Choice under Risk," Journal of Economic Literature, American Economic Association, vol. 38(2), pages 332-382, June.
  14. Tversky, Amos & Wakker, Peter, 1995. "Risk Attitudes and Decision Weights," Econometrica, Econometric Society, vol. 63(6), pages 1255-80, November.
  15. Harry Markowitz, 1952. "The Utility of Wealth," Journal of Political Economy, University of Chicago Press, vol. 60, pages 151.
  16. Matthew Rabin, 1998. "Psychology and Economics," Journal of Economic Literature, American Economic Association, vol. 36(1), pages 11-46, March.
  17. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
  18. Lehmann, Bruce N, 1990. "Fads, Martingales, and Market Efficiency," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 1-28, February.
  19. Andrew W. Lo, A. Craig MacKinlay, 1988. "Stock Market Prices do not Follow Random Walks: Evidence from a Simple Specification Test," Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 41-66.
  20. Frederick Mosteller & Philip Nogee, 1951. "An Experimental Measurement of Utility," Journal of Political Economy, University of Chicago Press, vol. 59, pages 371.
  21. Yaari, Menahem E, 1987. "The Dual Theory of Choice under Risk," Econometrica, Econometric Society, vol. 55(1), pages 95-115, January.
  22. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  23. Machina, Mark J, 1987. "Choice under Uncertainty: Problems Solved and Unsolved," Journal of Economic Perspectives, American Economic Association, vol. 1(1), pages 121-54, Summer.
  24. Quiggin, John, 1987. "Decision weights in anticipated utility theory : Response to Segal," Journal of Economic Behavior & Organization, Elsevier, vol. 8(4), pages 641-645, December.
  25. Levy, Haim & Wiener, Zvi, 1998. "Stochastic Dominance and Prospect Dominance with Subjective Weighting Functions," Journal of Risk and Uncertainty, Springer, vol. 16(2), pages 147-63, May-June.
  26. Nicholas Barberis & Ming Huang & Tano Santos, 2001. "Prospect Theory And Asset Prices," The Quarterly Journal of Economics, MIT Press, vol. 116(1), pages 1-53, February.
  27. Kihlstrom, Richard E. & Mirman, Leonard J., 1974. "Risk aversion with many commodities," Journal of Economic Theory, Elsevier, vol. 8(3), pages 361-388, July.
  28. Kihlstrom, Richard E & Mirman, Leonard J, 1981. "Constant, Increasing and Decreasing Risk Aversion with Many Commodities," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 271-80, April.
  29. Conrad, Jennifer & Kaul, Gautam, 1993. " Long-Term Market Overreaction or Biases in Computed Returns?," Journal of Finance, American Finance Association, vol. 48(1), pages 39-63, March.
  30. Richard H. Thaler & Eric J. Johnson, 1990. "Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice," Management Science, INFORMS, vol. 36(6), pages 643-660, June.
  31. Bruce N. Lehmann, 1988. "Fads, Martingales, and Market Efficiency," NBER Working Papers 2533, National Bureau of Economic Research, Inc.
  32. Shlomo Benartzi & Richard H. Thaler, 1993. "Myopic Loss Aversion and the Equity Premium Puzzle," NBER Working Papers 4369, National Bureau of Economic Research, Inc.
  33. Haim Levy, 1976. "Multi-Period Consumption Decision under Conditions of Uncertainty," Management Science, INFORMS, vol. 22(11), pages 1258-1267, July.
  34. Levy, Haim, 1994. "Absolute and Relative Risk Aversion: An Experimental Study," Journal of Risk and Uncertainty, Springer, vol. 8(3), pages 289-307, May.
  35. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56, pages 279.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Ewa Michalska & Renata Dudzinska-Baryla, 2012. "Comparison of the valuations of alternatives based on cumulative prospect theory and almost stochastic dominance," Operations Research and Decisions, Wroclaw University of Technology, Institute of Organization and Management, vol. 3, pages 23-36.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:eee:jebusi:v:68:y:2013:i:c:p:1-23. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.