Prospect theory is the main behavioral alternative to expected utility. Tversky and Kahnemann (1992) motivate the utility function for gains and losses under prospect theory by using the axiom of preference homogeneity. However, they do not provide the formal proof. We provide the relevant proof. Furthermore, we show that the utility function under preference homogeneity obeys an additional and important restriction that is not noted by Tversky and Kahnemann (1992). This simplifies the use of prospect theory by reducing the number of free parameters by one.
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Paper provided by Department of Economics, University of Leicester in its series Discussion Papers in Economics with number
06/15.
Length: Date of creation: Nov 2006 Date of revision: Handle: RePEc:lec:leecon:06/15
Contact details of provider: Postal: Department of Economics University of Leicester, University Road. Leicester. LE1 7RH. UK Phone: +44 (0)116 252 2887 Fax: +44 (0)116 252 2908 Email: Web page: http://www.le.ac.uk/economics/
Find related papers by JEL classification: C60 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - General D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
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