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Further Reflections on Prospect Theory

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Listed:
  • Susan K. Laury
  • Charles A. Holt

Abstract

This paper reports a new experimental test of prospect theoryâ??s reflection effect. We conduct a sequence of experiments that allow us to directly compare choices under reflected gains and losses where real and hypothetical payoffs range from several dollars to over $100. Lotteries with positive payoffs are transformed into lotteries over losses by reflecting all payoffs around zero. When we use hypothetical payments, more than half of the subjects who are risk averse for gains turn out to be risk seeking for losses. This "reflection effect" is diminished considerably with cash payoffs, where the modal choice pattern is to exhibit risk aversion for both gains and losses. However, we do observe a significant difference in risk attitudes between losses (where most subjects are approximately risk neutral) and gains (where most subjects are risk averse). Reflection rates are further reduced when payoffs are scaled up by a factor of 15 (for both real and hypothetical payoffs).

Suggested Citation

  • Susan K. Laury & Charles A. Holt, 2005. "Further Reflections on Prospect Theory," Experimental Economics Center Working Paper Series 2006-23, Experimental Economics Center, Andrew Young School of Policy Studies, Georgia State University.
    • Handle: RePEc:exc:wpaper:2006-23
    as

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    File URL: http://excen.gsu.edu/workingpapers/GSU_EXCEN_WP_2006-23.pdf
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    References listed on IDEAS

    as
    1. Smith, Vernon L & Walker, James M, 1993. "Monetary Rewards and Decision Cost in Experimental Economics," Economic Inquiry, Western Economic Association International, vol. 31(2), pages 245-261, April.
    2. Charles A. Holt & Susan K. Laury, 2002. "Risk Aversion and Incentive Effects," American Economic Review, American Economic Association, vol. 92(5), pages 1644-1655, December.
    3. Hans P. Binswanger, 1980. "Attitudes Toward Risk: Experimental Measurement in Rural India," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 62(3), pages 395-407.
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