A Satisficing Alternative to Prospect Theory
AbstractIn this paper, we axiomatize a target-based model of choice that allows decision makers to be both risk averse and risk seeking, depending on the payoff's position relative to a prespecified target. The approach can be viewed as a hybrid model, capturing in spirit two celebrated ideas: first, the satisficing concept of Simon (1955); second, the switch between risk aversion and risk seeking popularized by the prospect theory of Kahneman and Tversky (1979). Our axioms are simple and intuitive; in order to be implemented in practice, our approach requires only the specification of an aspiration level. We show that this approach is dual to a known approach using risk measures, thereby allowing us to connect to existing theory. Though our approach is intended to be normative, we also show that it resolves the classical examples of Allais (1953) and Ellsberg (1961).
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Bibliographic InfoPaper provided by Department of Economics, University of St. Gallen in its series University of St. Gallen Department of Economics working paper series 2009 with number 2009-09.
Length: 59 pages
Date of creation: May 2009
Date of revision:
satisficing; aspiration levels; targets; prospect theory; reflection effect; risk measures; coherent risk measures; convex risk measures; portfolio optimization;
Other versions of this item:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-05-23 (All new papers)
- NEP-CBE-2009-05-23 (Cognitive & Behavioural Economics)
- NEP-UPT-2009-05-23 (Utility Models & Prospect Theory)
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