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Risk Aversion in Cumulative Prospect Theory

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Author Info
Schmidt, Ulrich (Christian-Albrechts-Universit”t zu Kiel, The University of Manchester)
Horst Zank

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Abstract

This paper characterizes the conditions for risk aversion in cumulative prospect theory where risk aversion is defined in the strong sense (Rothshild Stiglitz 1970). Under weaker assumptions than differentiability we show that risk aversion implies convex weighting functions for gains and for losses but not necessarily a concave utility function. Also, we investigate the exact relationship between loss aversion and risk aversion. We illustrate the analysis by considering two special cases of cumulative prospect theory and show that risk aversion and convex utility may coexist.

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Publisher Info
Paper provided by Royal Economic Society in its series Royal Economic Society Annual Conference 2002 with number 162.

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Date of creation: 29 Aug 2002
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Handle: RePEc:ecj:ac2002:162

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Web page: http://www.res.org.uk/society/annualconf.asp
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  1. Ulrich Schmidt & Horst Zank, 2005. "What is Loss Aversion?," Journal of Risk and Uncertainty, Springer, vol. 30(2), pages 157-167, January. [Downloadable!] (restricted)
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  2. Ulrich Schmidt & Chris Starmer & Robert Sugden, 2008. "Third-generation prospect theory," Journal of Risk and Uncertainty, Springer, vol. 36(3), pages 203-223, June. [Downloadable!] (restricted)
  3. Ulrich Schmidt & Horst Zank, 2007. "Linear cumulative prospect theory with applications to portfolio selection and insurance demand," Decisions in Economics and Finance, Springer, vol. 30(1), pages 1-18, 05. [Downloadable!] (restricted)
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