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Risk Aversion in Cumulative Prospect Theory

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Author Info

  • Ulrich Schmidt

    ()
    (Department of Economics, Christian-Albrechts-Universität zu Kiel, 24098 Kiel, Germany and Kiel Institute for the World Economy, 24105 Kiel, Germany)

  • Horst Zank

    ()
    (Department of Economics, School of Social Sciences, University of Manchester, Manchester M13 9PL, United Kingdom)

Abstract

This paper characterizes the conditions for strong risk aversion and second-order stochastic dominance for cumulative prospect theory. Strong risk aversion implies a convex weighting function for gains and a concave one for losses. It does not necessarily imply a concave utility function. The latter does follow if the weighting functions are continuous. By investigating the exact relationship between loss aversion and strong risk aversion, a natural index for the degree of loss aversion is derived.

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File URL: http://dx.doi.org/10.1287/mnsc.1070.0762
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Bibliographic Info

Article provided by INFORMS in its journal Management Science.

Volume (Year): 54 (2008)
Issue (Month): 1 (January)
Pages: 208-216

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Handle: RePEc:inm:ormnsc:v:54:y:2008:i:1:p:208-216

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Related research

Keywords: cumulative prospect theory; loss aversion; risk aversion; second-order stochastic dominance; decision analysis theory; risk;

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Cited by:
  1. Jie Zhang & Ivan Paya & David Peel, 2010. "An Empirical Analysis of Choices Between Gambles of Children and Adults in China," Journal of Gambling Business and Economics, University of Buckingham Press, vol. 4(1), pages 1-18, March.
  2. Horst Zank, 2010. "On probabilities and loss aversion," Theory and Decision, Springer, vol. 68(3), pages 243-261, March.
  3. Stefan Zeisberger & Dennis Vrecko & Thomas Langer, 2012. "Measuring the time stability of Prospect Theory preferences," Theory and Decision, Springer, vol. 72(3), pages 359-386, March.
  4. Ulrich Schmidt & Horst Zank, 2011. "A Genuine Foundation for Prospect Theory," The School of Economics Discussion Paper Series 1114, Economics, The University of Manchester.
  5. Stefan Zeisberger & Thomas Langer & Martin Weber, 2012. "Why does myopia decrease the willingness to invest? Is it myopic loss aversion or myopic loss probability aversion?," Theory and Decision, Springer, vol. 72(1), pages 35-50, January.
  6. Ryan, Matthew J., 2006. "Risk aversion in RDEU," Journal of Mathematical Economics, Elsevier, vol. 42(6), pages 675-697, September.
  7. U Schmidt & H Zank, 2002. "What is Loss Aversion?," The School of Economics Discussion Paper Series 0209, Economics, The University of Manchester.
  8. U Schmidt & H Zank, 2002. "Linear Cumulative Prospect Theory with Applications to Portfolio Selection and Insurance Demand," The School of Economics Discussion Paper Series 0208, Economics, The University of Manchester.
  9. Alexander Morell & Andreas Glöckner & Emanuel Towfigh, 2009. "Sticky Rebates: Rollback Rebates Induce Non-Rational Loyalty in Consumers," Working Paper Series of the Max Planck Institute for Research on Collective Goods 2009_23, Max Planck Institute for Research on Collective Goods, revised Feb 2013.
  10. Mohammed Abdellaoui & Olivier l’Haridon & Horst Zank, 2009. "Separating Curvature and Elevation: A Parametric Weighting Function," The School of Economics Discussion Paper Series 0901, Economics, The University of Manchester.
  11. Mohammed Abdellaoui & Olivier L’Haridon & Horst Zank, 2010. "Separating curvature and elevation: A parametric probability weighting function," Journal of Risk and Uncertainty, Springer, vol. 41(1), pages 39-65, August.
  12. Botzen, W.J.W. & van den Bergh, J.C.J.M., 2012. "Risk attitudes to low-probability climate change risks: WTP for flood insurance," Journal of Economic Behavior & Organization, Elsevier, vol. 82(1), pages 151-166.
  13. Dierkes, Maik & Erner, Carsten & Zeisberger, Stefan, 2010. "Investment horizon and the attractiveness of investment strategies: A behavioral approach," Journal of Banking & Finance, Elsevier, vol. 34(5), pages 1032-1046, May.
  14. Schmidt, Ulrich & Starmer, Chris & Sugden, Robert, 2008. "Third-generation prospect theory," Open Access Publications from Kiel Institute for the World Economy 28932, Kiel Institute for the World Economy (IfW).
  15. Maier, Johannes & Rüger, Maximilian, 2010. "Measuring Risk Aversion Model-Independently," Discussion Papers in Economics 11873, University of Munich, Department of Economics.
  16. Mao-Wei Hung & Jr-Yan Wang, 2011. "Loss aversion and the term structure of interest rates," Applied Economics, Taylor & Francis Journals, vol. 43(29), pages 4623-4640.
  17. Lefebvre, Mathieu & Vieider, Ferdinand M., 2014. "Risk taking of executives under different incentive contracts: Experimental evidence," Journal of Economic Behavior & Organization, Elsevier, vol. 97(C), pages 27-36.

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