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Prospect Theory for Continuous Distributions Games and Prospects

Author

Listed:
  • Marc Oliver Rieger

    (ETH Zurich, Department of Mathematics)

  • Mei Wang

    (University of Zurich, ISB)

Abstract

We extend the original form of Prospect Theory by Kahneman and Tversky from finite lotteries to arbitrary probability distributions, thus paving the way for applications in economics and finance. Moreover, we suggest a method how to incorporate a crucial step of the “editing phase” into Prospect Theory and to remove in this way the discontinuity of the original model.

Suggested Citation

  • Marc Oliver Rieger & Mei Wang, 2007. "Prospect Theory for Continuous Distributions Games and Prospects," Swiss Finance Institute Research Paper Series 07-30, Swiss Finance Institute.
  • Handle: RePEc:chf:rpseri:rp0730
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    File URL: http://ssrn.com/abstract=1020042
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    References listed on IDEAS

    as
    1. Robert J. Barro, 2006. "Rare Disasters and Asset Markets in the Twentieth Century," The Quarterly Journal of Economics, Oxford University Press, pages 823-866.
    2. Robert E. Hoyt & Kathleen A. McCullough, 1999. "Catastrophe Insurance Options: Are They Zero-Beta Assets?," Journal of Insurance Issues, Western Risk and Insurance Association, vol. 22(2), pages 147-163.
    3. Philippe Artzner & Freddy Delbaen & Jean-Marc Eber & David Heath, 1999. "Coherent Measures of Risk," Mathematical Finance, Wiley Blackwell, vol. 9(3), pages 203-228.
    4. Sujoy Mukerji & Jean-Marc Tallon, 2001. "Ambiguity Aversion and Incompleteness of Financial Markets," Review of Economic Studies, Oxford University Press, vol. 68(4), pages 883-904.
    5. Cummins, J. David & Lalonde, David & Phillips, Richard D., 2004. "The basis risk of catastrophic-loss index securities," Journal of Financial Economics, Elsevier, vol. 71(1), pages 77-111, January.
    6. Barrieu, Pauline & El Karoui, Nicole, 2005. "Inf-convolution of risk measures and optimal risk transfer," LSE Research Online Documents on Economics 2829, London School of Economics and Political Science, LSE Library.
    7. Rietz, Thomas A., 1988. "The equity risk premium a solution," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 117-131, July.
    8. Pauline Barrieu & Nicole El Karoui, 2005. "Inf-convolution of risk measures and optimal risk transfer," Finance and Stochastics, Springer, vol. 9(2), pages 269-298, April.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Prospect Theory; Cumulative Prospect Theory; continuity; probability weighting; first-order stochastic dominance.;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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