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Gain-Loss Hedging and Cumulative Prospect Theory

Author

Listed:
  • Lorenzo Bastianello

    (Universite Paris 2 Pantheon-Assas, LEMMA, Paris, France)

  • Alain Chateauneuf

    (IPAG Business School, Paris, France and Paris School of Economics and Universite Paris 1, Paris, France)

  • Bernard Cornet

    (Department of Economics, University of Kansas, Lawrence, KS 66045, USA)

Abstract

Two acts are comonotonic if they co-vary in the same direction. The main purpose of this paper is to derive a new characterization of Cumulative Prospect Theory (CPT) through simple properties involving comonotonicity. The main novelty is a concept dubbed gain-loss hedging: mixing positive and negative acts creates hedging possibilities even when acts are comonotonic. This allows us to clarify in which sense CPT differs from Choquet expected utility. Our analysis is performed under the assumption that acts are real-valued functions. This entails a simple (piece-wise) constant marginal utility representation of CPT, which allows us to clearly separate the perception of uncertainty from the evaluation of outcomes.

Suggested Citation

  • Lorenzo Bastianello & Alain Chateauneuf & Bernard Cornet, 2025. "Gain-Loss Hedging and Cumulative Prospect Theory," WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS 202511, University of Kansas, Department of Economics.
    • Handle: RePEc:kan:wpaper:202511
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    File URL: https://kuwpaper.ku.edu/2025Papers/202511.pdf
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    More about this item

    Keywords

    Cumulative Prospect Theory; Comonotonicity; Gain-loss hedging; Sipos integral; Choquet integral.;
    All these keywords.

    JEL classification:

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

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