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Absolute vs. Relative Notion of Wealth Changes

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  • Kontek, Krzysztof

Abstract

This paper discusses solutions derived from lottery experiments using two alternative assumptions: that people perceive wealth changes as absolute amounts of money; and that people consider wealth changes as a proportion of some reference value dependant on the context of the problem under consideration. The former assumption leads to the design of Prospect Theory, the latter - to a solution closely resembling the utility function hypothesized by Markowitz (1952). This paper presents several crucial arguments for the latter approach and provides strong arguments for rejecting the Prospect Theory paradigm.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 17336.

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Date of creation: 16 Sep 2009
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Handle: RePEc:pra:mprapa:17336

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Related research

Keywords: Prospect / Cumulative Prospect Theory; Probability Weighting Function; Markowitz Hypothesis; Aspiration / Relative Utility Function / Theory; Mental Accounts; Problem Framing and Scaling; Psychophysics; Weber’s Law; Experimental Design; Lottery; Decision Making Under Risk;

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References

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  1. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March.
  2. Kontek, Krzysztof, 2009. "On Mental Transformations," MPRA Paper 16516, University Library of Munich, Germany.
  3. Krzysztof Kontek, 2009. "Lottery valuation using the aspiration / relative utility function," Working Papers 39, Department of Applied Econometrics, Warsaw School of Economics.
  4. Richard Thaler, 1985. "Mental Accounting and Consumer Choice," Marketing Science, INFORMS, vol. 4(3), pages 199-214.
  5. Harry Markowitz, 1952. "The Utility of Wealth," Journal of Political Economy, University of Chicago Press, vol. 60, pages 151.
  6. 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.
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Cited by:
  1. Kontek, Krzysztof, 2010. "Mean, Median or Mode? A Striking Conclusion From Lottery Experiments," MPRA Paper 21758, University Library of Munich, Germany.
  2. Kontek, Krzysztof, 2009. "The Illusion of Irrationality," MPRA Paper 19044, University Library of Munich, Germany.

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