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Cumulative prospect theory and the St.Petersburg paradox

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  • Rieger, Marc Oliver
  • Wang, Mei

Abstract

We find that in cumulative prospect theory (CPT) with a concave value function in gains, a lottery with finite expected value may have infinite subjective value. This problem does not occur in expected utility theory. We characterize situations in CPT where the problem can be resolved. In particular, we define a class of admissible probability distributions and admissible parameter regimes for the weighting-- and value functions. In both cases, finiteness of the subjective value can be proved. Alternatively, we suggest a new weighting function for CPT which guarantees finite subjective value for all lotteries with finite expected value, independent of the choice of the value function.

Suggested Citation

  • Rieger, Marc Oliver & Wang, Mei, 2004. "Cumulative prospect theory and the St.Petersburg paradox," Papers 04-28, Sonderforschungsbreich 504.
    • Handle: RePEc:mnh:spaper:2714
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    File URL: https://madoc.bib.uni-mannheim.de/2714/1/dp04_28.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Cumulative Prospect Theory ; Probability Weighting Function ; St. Petersburg Paradox;
    All these keywords.

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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