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On Mental Transformations

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  • Kontek, Krzysztof

Abstract

The paper presents an alternative interpretation of the experimental data published by Kahneman and Tversky in their 1992 study "Advances in Prospect Theory”, which describes the Cumulative version of their Prospect Theory from 1979. It was assumed that, apart from the operations made during the initial stage of problem resolution, which Prospect Theory defines as Editing (here generalized as Mental Adaptation), other mental transformations such as Prospect Scaling (resulting from Focused Attention) and Logarithmic Perception of Financial Stimuli should be considered when analyzing the experimental data. This led to the design of an explicit, simple and symmetric solution without the use of the probability weighting function. The double S-type function obtained (the aspiration function) resembles the utility curve specified by the Markowitz hypothesis (1952) and substitutes the fourfold pattern of risk attitudes introduced by Cumulative Prospect Theory. The results presented constitute a basis for negating Prospect Theory as a theory which correctly describes how decisions are made under conditions of risk and may signal a return to a description of people’s behavior that only relies on the utility-like function.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 16516.

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Date of creation: 25 Mar 2009
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Handle: RePEc:pra:mprapa:16516

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Keywords: Prospect/Cumulative Prospect Theory; Markowitz Utility Hypothesis; Utility & Aspiration Functions; Mental Processes; Adaptation & Attention Focus;

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References

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  1. Richard Thaler, 1985. "Mental Accounting and Consumer Choice," Marketing Science, INFORMS, INFORMS, vol. 4(3), pages 199-214.
  2. Harry Markowitz, 1952. "The Utility of Wealth," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 60, pages 151.
  3. Schmeidler, David, 1989. "Subjective Probability and Expected Utility without Additivity," Econometrica, Econometric Society, Econometric Society, vol. 57(3), pages 571-87, May.
  4. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  5. Shefrin, Hersh & Statman, Meir, 1985. " The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence," Journal of Finance, American Finance Association, American Finance Association, vol. 40(3), pages 777-90, July.
  6. Wakker, Peter, 1989. "Continuous subjective expected utility with non-additive probabilities," Journal of Mathematical Economics, Elsevier, vol. 18(1), pages 1-27, February.
  7. Wakker, Peter, 1990. "Characterizing optimism and pessimism directly through comonotonicity," Journal of Economic Theory, Elsevier, Elsevier, vol. 52(2), pages 453-463, December.
  8. George Wu & Richard Gonzalez, 1996. "Curvature of the Probability Weighting Function," Management Science, INFORMS, INFORMS, vol. 42(12), pages 1676-1690, December.
  9. Camerer, Colin F & Ho, Teck-Hua, 1994. "Violations of the Betweenness Axiom and Nonlinearity in Probability," Journal of Risk and Uncertainty, Springer, Springer, vol. 8(2), pages 167-96, March.
  10. Loomes, Graham & Sugden, Robert, 1982. "Regret Theory: An Alternative Theory of Rational Choice under Uncertainty," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 92(368), pages 805-24, December.
  11. Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, Econometric Society, vol. 66(3), pages 497-528, May.
  12. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard H, 1990. "Experimental Tests of the Endowment Effect and the Coase Theorem," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 98(6), pages 1325-48, December.
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Citations

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Cited by:
  1. Kontek, Krzysztof, 2009. "Absolute vs. Relative Notion of Wealth Changes," MPRA Paper 17336, University Library of Munich, Germany.
  2. Emilia Tomczyk, 2013. "End of sample vs. real time data: perspectives for analysis of expectations," Working Papers, Department of Applied Econometrics, Warsaw School of Economics 68, Department of Applied Econometrics, Warsaw School of Economics.
  3. Krzysztof Kontek, 2009. "Lottery valuation using the aspiration / relative utility function," Working Papers, Department of Applied Econometrics, Warsaw School of Economics 39, Department of Applied Econometrics, Warsaw School of Economics.
  4. Marc Scholten & Daniel Read, 2014. "Prospect theory and the “forgotten” fourfold pattern of risk preferences," Journal of Risk and Uncertainty, Springer, Springer, vol. 48(1), pages 67-83, February.
  5. Krzysztof Kontek & Michal Lewandowski, 2013. "Range-Dependent Utility," Working Papers, Department of Applied Econometrics, Warsaw School of Economics 69, Department of Applied Econometrics, Warsaw School of Economics.
  6. Kontek, Krzysztof, 2010. "Multi-Outcome Lotteries: Prospect Theory vs. Relative Utility," MPRA Paper 22947, University Library of Munich, Germany.

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