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An Empirical Test of Gain-Loss Separability in Prospect Theory

Author

Listed:
  • George Wu

    (Center for Decision Research, Graduate School of Business, University of Chicago, Chicago, Illinois 60637)

  • Alex B. Markle

    (Stern School of Business, New York University, New York, New York 10012)

Abstract

We investigate a basic premise of prospect theory: that the valuation of gains and losses is separable. In prospect theory, gain-loss separability implies that a mixed gamble is valued by summing the valuations of the gain and loss portions of that gamble. Two experimental studies demonstrate a systematic violation of the double-matching axiom, an axiom that is necessary for gain-loss separability. We document a reversal between preferences for mixed gambles and the associated gain and loss gambles--mixed gamble A is preferred to mixed gamble B, but the gain and loss portions of B are preferred to the gain and loss portions of A. The observed choice patterns are consistent with a process in which individuals are less sensitive to probability differences when choosing among mixed gambles than when choosing among either gain or loss gambles.

Suggested Citation

  • George Wu & Alex B. Markle, 2008. "An Empirical Test of Gain-Loss Separability in Prospect Theory," Management Science, INFORMS, vol. 54(7), pages 1322-1335, July.
  • Handle: RePEc:inm:ormnsc:v:54:y:2008:i:7:p:1322-1335
    DOI: 10.1287/mnsc.1070.0846
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    References listed on IDEAS

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