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Third-generation prospect theory

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  • Schmidt, Ulrich
  • Starmer, Chris
  • Sugden, Robert

Abstract

We present a new theory of decision under uncertainty: third-generation prospect theory (PT3). This retains the predictive power of previous versions of prospect theory, but extends that theory by allowing reference points to be uncertain while decision weights are specified in a rank-dependent way. We show that PT3 preferences respect a state-conditional form of stochastic dominance. The theory predicts the observed tendency for willingness-to-accept valuations of lotteries to be greater than willingness-to-pay valuations. When PT3 is made operational by using simple functional forms with parameter values derived from existing experimental evidence, it predicts observed patterns of the preference reversal phenomenon.

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Bibliographic Info

Paper provided by Kiel Institute for the World Economy in its series Open Access publications from Kiel Institute for the World Economy with number info:hdl:10419/28932.

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Date of creation: 2008
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Publication status: Published in Journal of risk and uncertainty : JRU (2008) v.36, p.203-223
Handle: RePEc:ner:ifwkie:info:hdl:10419/28932

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Web page: http://www.ifw-kiel.de

Related research

Keywords: Prospect theory; Preference reversal; Reference dependence;

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References

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Citations

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Cited by:
  1. Fortin, Ines & Hlouskova, Jaroslava, 2011. "Optimal asset allocation under linear loss aversion," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 2974-2990, November.
  2. Ulrich Schmidt & Horst Zank, 2011. "A Genuine Foundation for Prospect Theory," The School of Economics Discussion Paper Series 1114, Economics, The University of Manchester.
  3. Steffen Andersen & Glenn W. Harrison & Morten Igel Lau & Elisabet E. Rutstroem, 2007. "Behavioral Econometrics for Psychologists," Working Papers 2007_08, Durham University Business School.
  4. Graham Loomes & Shepley Orr & Robert Sugden, 2009. "Taste uncertainty and status quo effects in consumer choice," Journal of Risk and Uncertainty, Springer, vol. 39(2), pages 113-135, October.
  5. Sanjit Dhami & Ali al-Nowaihi, 2011. "An extension of the Becker proposition to non-expected utility theory," Discussion Papers in Economics 11/41, Department of Economics, University of Leicester.
  6. Horst Zank, 2010. "On probabilities and loss aversion," Theory and Decision, Springer, vol. 68(3), pages 243-261, March.
  7. Pavlo Blavatskyy, 2009. "Preference reversals and probabilistic decisions," Journal of Risk and Uncertainty, Springer, vol. 39(3), pages 237-250, December.
  8. Drichoutis, Andreas & Nayga, Rodolfo & Klonaris, Stathis, 2010. "The Effects of Induced Mood on Preference Reversals and Bidding Behavior in Experimental Auction Valuation," MPRA Paper 25597, University Library of Munich, Germany.
  9. Stefan T. Trautmann & Ulrich Schmidt, 2011. "Pricing risk and ambiguity: The effect of perspective taking," Kiel Working Papers 1727, Kiel Institute for the World Economy.
  10. Butler, David & Loomes, Graham, 2011. "Imprecision as an account of violations of independence and betweenness," Journal of Economic Behavior & Organization, Elsevier, vol. 80(3), pages 511-522.
  11. Fortin, Ines & Hlouskova, Jaroslava, 2012. "Optimal Asset Allocation under Quadratic Loss Aversion," Economics Series 291, Institute for Advanced Studies.
  12. Croson, Rachel & Gächter, Simon, 2010. "The science of experimental economics," Journal of Economic Behavior & Organization, Elsevier, vol. 73(1), pages 122-131, January.
  13. W. Viscusi & Joel Huber, 2012. "Reference-dependent valuations of risk: Why willingness-to-accept exceeds willingness-to-pay," Journal of Risk and Uncertainty, Springer, vol. 44(1), pages 19-44, February.
  14. Ulrich Schmidt, 2012. "Insurance Demand and Prospect Theory," Kiel Working Papers 1750, Kiel Institute for the World Economy.
  15. 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.
  16. Liu, Shuangzhe & Ma, Tiefeng & Polasek, Wolfgang, 2012. "Spatial System Estimators for Panel Models: A Sensitivity and Simulation Study," Economics Series 294, Institute for Advanced Studies.
  17. Enrico G. De Giorgi & Thierry Post, 2010. "Loss aversion with a state-dependent reference point," University of St. Gallen Department of Economics working paper series 2010 2010-23, Department of Economics, University of St. Gallen.
  18. Lindsey, Robin, 2011. "State-dependent congestion pricing with reference-dependent preferences," Transportation Research Part B: Methodological, Elsevier, vol. 45(10), pages 1501-1526.

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