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Loss Aversion And Ruinous Optimal Wagers In Cumulative Prospect Theory

Author

Listed:
  • David Alan Peel

    (University of Lancaster Dept.Economics)

  • David Law

    (University of Bangor)

Abstract

We demonstrate that extant parametric specifications of Cumulative Prospect Theory exhibit counterfactual implications for optimal wagers at actuarially unfair odds. In particular they imply individuals may maximizes their utility, called value function in Cumulative Prospect Theory, by wagering all or large proportions of their wealth on actuarially unfair gambles. In order to eliminate this property it is necessary that loss aversion is unbounded and increases as stake size increases. We present new parametric specifications of the value function over losses that exhibit this feature and therefore eliminate the ruinous wagering property

Suggested Citation

  • David Alan Peel & David Law, 2017. "Loss Aversion And Ruinous Optimal Wagers In Cumulative Prospect Theory," Economics Bulletin, AccessEcon, vol. 37(1), pages 352-360.
    • Handle: RePEc:ebl:ecbull:eb-16-00345
    as

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    References listed on IDEAS

    as
    1. Lisa Cameron & Manisha Shah, 2015. "Risk-Taking Behavior in the Wake of Natural Disasters," Journal of Human Resources, University of Wisconsin Press, vol. 50(2), pages 484-515.
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Cumulative Prospect Theory; Loss Aversion; Optimal Wagering;
    All these keywords.

    JEL classification:

    • B4 - Schools of Economic Thought and Methodology - - Economic Methodology

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