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Measuring the Utility of Losses by Means of the Tradeoff Method

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  • Fennema, Hein
  • van Assen, Marcel
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    Abstract

    This paper investigates the shape of the utility function for losses. From a rational point of view it can be argued that utility should be concave. Empirically, measurements of the utility for losses show mixed results but most evidence supports convex rather than concave utilities. However, these measurements use methods that are either biased by the certainty effect or require complex parametrical estimations. This paper re-examines utility for losses, avoiding the mentioned pitfalls by using the tradeoff method. We find that utility for losses is convex. This is contrary to common assumption in the economics literature. Also, we investigate properties of the tradeoff method showing a new violation of procedure invariance. Our findings demonstrate that diminishing sensitivity is an important phenomenon for utility elicitation. Copyright 1998 by Kluwer Academic Publishers

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    Bibliographic Info

    Article provided by Springer in its journal Journal of Risk and Uncertainty.

    Volume (Year): 17 (1998)
    Issue (Month): 3 (December)
    Pages: 277-95

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    Handle: RePEc:kap:jrisku:v:17:y:1998:i:3:p:277-95

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    Web page: http://www.springerlink.com/link.asp?id=100299

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    Cited by:
    1. Booij, Adam S. & van de Kuilen, Gijs, 2009. "A parameter-free analysis of the utility of money for the general population under prospect theory," Journal of Economic Psychology, Elsevier, vol. 30(4), pages 651-666, August.
    2. Marc Scholten & Daniel Read, 2014. "Prospect theory and the “forgotten” fourfold pattern of risk preferences," Journal of Risk and Uncertainty, Springer, vol. 48(1), pages 67-83, February.
    3. Gabriela Flores & Owen O'Donnell, 2012. "Catastrophic Medical Expenditure Risk," Tinbergen Institute Discussion Papers 12-078/3, Tinbergen Institute.
    4. Wong, Wing-Keung, 2007. "Stochastic dominance and mean-variance measures of profit and loss for business planning and investment," European Journal of Operational Research, Elsevier, vol. 182(2), pages 829-843, October.
    5. Aurélien Baillon & Laure Cabantous & Peter Wakker, 2012. "Aggregating imprecise or conflicting beliefs: An experimental investigation using modern ambiguity theories," Journal of Risk and Uncertainty, Springer, vol. 44(2), pages 115-147, April.
    6. Wakker, Peter P. & Zank, Horst, 2002. "A simple preference foundation of cumulative prospect theory with power utility," European Economic Review, Elsevier, vol. 46(7), pages 1253-1271, July.
    7. Adam Booij & Bernard Praag & Gijs Kuilen, 2010. "A parametric analysis of prospect theory’s functionals for the general population," Theory and Decision, Springer, vol. 68(1), pages 115-148, February.
    8. Davies, G.B. & Satchell, S.E., 2004. "Continuous Cumulative Prospect Theory and Individual Asset Allocation," Cambridge Working Papers in Economics 0467, Faculty of Economics, University of Cambridge.
    9. Kobberling, Veronika & Wakker, Peter P., 2005. "An index of loss aversion," Journal of Economic Theory, Elsevier, vol. 122(1), pages 119-131, May.
    10. Michael H. Birnbaum & Jeffrey P. Bahra, 2007. "Gain-Loss Separability and Coalescing in Risky Decision Making," Management Science, INFORMS, vol. 53(6), pages 1016-1028, June.
    11. Coelho, Luís Alberto Godinho & Pires, Cesaltina Maria Pacheco & Dionísio, Andreia Teixeira & Serrão, Amílcar Joaquim da Conceição, 2012. "The impact of CAP policy in farmer's behavior – A modeling approach using the Cumulative Prospect Theory," Journal of Policy Modeling, Elsevier, vol. 34(1), pages 81-98.
    12. Gabriela Flores & Owen O'Donnell, 2012. "Catastrophic Medical Expenditure Risk," Tinbergen Institute Discussion Papers 12-078/3, Tinbergen Institute.
    13. Jou, Rong-Chang & Chen, Ke-Hong, 2013. "An application of cumulative prospect theory to freeway drivers’ route choice behaviours," Transportation Research Part A: Policy and Practice, Elsevier, vol. 49(C), pages 123-131.
    14. Peter Wakker & Veronika Köbberling & Christiane Schwieren, 2007. "Prospect-theory’s Diminishing Sensitivity Versus Economics’ Intrinsic Utility of Money: How the Introduction of the Euro can be Used to Disentangle the Two Empirically," Theory and Decision, Springer, vol. 63(3), pages 205-231, November.

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