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A Further Examination of Cumulative Prospect Theory Parameterizations

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  • Neilson, William S
  • Stowe, Jill

Abstract

Recent experimental studies have focused on fitting parameterized functional forms to cumulative prospect theory's weighting function. This paper examines the behavioral implications of the functional forms and the estimated parameters. We find that none of the parameterizations can simultaneously account for gambling on unlikely gains and the Allais paradox behavior or other strong choice patterns from experiments. Parameter estimates that lead to reasonable amounts of insurance and gambling behavior tend to also generate large risk premia. Taken as a whole, the analysis suggests that the functional forms proposed in the literature are not suitable for generalization to applied settings. Copyright 2002 by Kluwer Academic Publishers

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Bibliographic Info

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

Volume (Year): 24 (2002)
Issue (Month): 1 (January)
Pages: 31-46

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Handle: RePEc:kap:jrisku:v:24:y:2002:i:1:p:31-46

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

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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. Bernasconi, Michele, 1998. "Tax evasion and orders of risk aversion," Journal of Public Economics, Elsevier, vol. 67(1), pages 123-134, January.
  3. Matthew Rabin, 2000. "Risk Aversion and Expected-Utility Theory: A Calibration Theorem," Econometrica, Econometric Society, vol. 68(5), pages 1281-1292, September.
  4. Camerer, Colin F & Ho, Teck-Hua, 1994. "Violations of the Betweenness Axiom and Nonlinearity in Probability," Journal of Risk and Uncertainty, Springer, vol. 8(2), pages 167-96, March.
  5. Fox, Craig R & Rogers, Brett A & Tversky, Amos, 1996. "Options Traders Exhibit Subadditive Decision Weights," Journal of Risk and Uncertainty, Springer, vol. 13(1), pages 5-17, July.
  6. Battalio, Raymond C & Kagel, John H & Jiranyakul, Komain, 1990. " Testing between Alternative Models of Choice under Uncertainty: Some Initial Results," Journal of Risk and Uncertainty, Springer, vol. 3(1), pages 25-50, March.
  7. George Wu & Richard Gonzalez, 1996. "Curvature of the Probability Weighting Function," Management Science, INFORMS, vol. 42(12), pages 1676-1690, December.
  8. 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.
  9. Colin Camerer, 1998. "Bounded Rationality in Individual Decision Making," Experimental Economics, Springer, vol. 1(2), pages 163-183, September.
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Citations

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Cited by:
  1. Gemmill, Gordon T & Hwang, Soosung & Salmon, Mark, 2005. "Performance Measurement with Loss Aversion," CEPR Discussion Papers 5173, C.E.P.R. Discussion Papers.
  2. Liang, Che-Yuan, 2013. "Optimal Inequality behind the Veil of Ignorance," Working Paper Series 2013:7, Uppsala University, Department of Economics.
  3. Serge Blondel & Louis Lévy-garboua, 2011. "Can non-expected utility theories explain the paradox of not voting?," Economics Bulletin, AccessEcon, vol. 31(4), pages 3158-3168.
  4. John Hey, 2005. "Why We Should Not Be Silent About Noise," Experimental Economics, Springer, vol. 8(4), pages 325-345, December.
  5. LiCalzi, Marco & Sorato, Annamaria, 2006. "The Pearson system of utility functions," European Journal of Operational Research, Elsevier, vol. 172(2), pages 560-573, July.
  6. Diecidue, E. & Wakker, P.P. & Zeelenberg, M., 2007. "Eliciting decision weights by adapting de Finetti's betting-odds method to prospect theory," Open Access publications from Tilburg University urn:nbn:nl:ui:12-225938, Tilburg University.
  7. Marie Pfiffelmann, 2007. "How to solve the St Petersburg Paradox in Rank-Dependent Models ?," Working Papers of LaRGE Research Center 2007-08, Laboratoire de Recherche en Gestion et Economie (LaRGE), Université de Strasbourg (France).
  8. Amadeo Piolatto & Matthew Rablen, 2013. "Prospect theory and tax evasion: a reconsideration of the Yitzhaki Puzzle," IFS Working Papers W13/25, Institute for Fiscal Studies.
  9. Charles Mason & Jason Shogren & Chad Settle & John List, 2005. "Investigating Risky Choices Over Losses Using Experimental Data," Journal of Risk and Uncertainty, Springer, vol. 31(2), pages 187-215, September.
  10. Marie Pfiffelmann, 2011. "Solving the St. Petersburg Paradox in cumulative prospect theory: the right amount of probability weighting," Theory and Decision, Springer, vol. 71(3), pages 325-341, September.
  11. Valery Polkovnichenko, 2005. "Household Portfolio Diversification: A Case for Rank-Dependent Preferences," Review of Financial Studies, Society for Financial Studies, vol. 18(4), pages 1467-1502.
  12. Peel, D.A. & Zhang, Jie, 2009. "The expo-power value function as a candidate for the work-horse specification in parametric versions of cumulative prospect theory," Economics Letters, Elsevier, vol. 105(3), pages 326-329, December.
  13. Pavlo R. Blavatskyy, . "A Stochastic Expected Utility Theory," IEW - Working Papers 231, Institute for Empirical Research in Economics - University of Zurich.
  14. D. A. Peel & Jie Zhang & D. Law, 2008. "The Markowitz model of utility supplemented with a small degree of probability distortion as an explanation of outcomes of Allais experiments over large and small payoffs and gambling on unlikely outc," Applied Economics, Taylor & Francis Journals, vol. 40(1), pages 17-26.
  15. Davies, G.B., 2005. "Rethinking Risk: Aspiration as Pure Risk," Cambridge Working Papers in Economics 0507, Faculty of Economics, University of Cambridge.
  16. Konstantinos Katsikopoulos & Gerd Gigerenzer, 2008. "One-reason decision-making: Modeling violations of expected utility theory," Journal of Risk and Uncertainty, Springer, vol. 37(1), pages 35-56, August.
  17. Markus Pasche, 2013. "What Can be Learned from Behavioural Economics for Environmental Policy?," Jena Economic Research Papers 2013-020, Friedrich-Schiller-University Jena, Max-Planck-Institute of Economics.
  18. Hwang, Soosung & Satchell, Steve E., 2010. "How loss averse are investors in financial markets?," Journal of Banking & Finance, Elsevier, vol. 34(10), pages 2425-2438, October.

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