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Risk Aversion in Cumulative Prospect Theory

  • Ulrich Schmidt

    ()

    (Department of Economics, Christian-Albrechts-Universität zu Kiel, 24098 Kiel, Germany and Kiel Institute for the World Economy, 24105 Kiel, Germany)

  • Horst Zank

    ()

    (Department of Economics, School of Social Sciences, University of Manchester, Manchester M13 9PL, United Kingdom)

This paper characterizes the conditions for strong risk aversion and second-order stochastic dominance for cumulative prospect theory. Strong risk aversion implies a convex weighting function for gains and a concave one for losses. It does not necessarily imply a concave utility function. The latter does follow if the weighting functions are continuous. By investigating the exact relationship between loss aversion and strong risk aversion, a natural index for the degree of loss aversion is derived.

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File URL: http://dx.doi.org/10.1287/mnsc.1070.0762
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Article provided by INFORMS in its journal Management Science.

Volume (Year): 54 (2008)
Issue (Month): 1 (January)
Pages: 208-216

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Handle: RePEc:inm:ormnsc:v:54:y:2008:i:1:p:208-216
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