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On Mental Transformations

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  • Kontek, Krzysztof

Abstract

The paper presents an alternative interpretation of the experimental data published by Kahneman and Tversky in their 1992 study "Advances in Prospect Theory”, which describes the Cumulative version of their Prospect Theory from 1979. It was assumed that, apart from the operations made during the initial stage of problem resolution, which Prospect Theory defines as Editing (here generalized as Mental Adaptation), other mental transformations such as Prospect Scaling (resulting from Focused Attention) and Logarithmic Perception of Financial Stimuli should be considered when analyzing the experimental data. This led to the design of an explicit, simple and symmetric solution without the use of the probability weighting function. The double S-type function obtained (the aspiration function) resembles the utility curve specified by the Markowitz hypothesis (1952) and substitutes the fourfold pattern of risk attitudes introduced by Cumulative Prospect Theory. The results presented constitute a basis for negating Prospect Theory as a theory which correctly describes how decisions are made under conditions of risk and may signal a return to a description of people’s behavior that only relies on the utility-like function.

Suggested Citation

  • Kontek, Krzysztof, 2009. "On Mental Transformations," MPRA Paper 16516, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:16516
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    References listed on IDEAS

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    1. Loomes, Graham & Sugden, Robert, 1982. "Regret Theory: An Alternative Theory of Rational Choice under Uncertainty," Economic Journal, Royal Economic Society, vol. 92(368), pages 805-824, December.
    2. Harry Markowitz, 1952. "The Utility of Wealth," Journal of Political Economy, University of Chicago Press, vol. 60, pages 151-151.
    3. Richard H. Thaler, 2008. "Mental Accounting and Consumer Choice," Marketing Science, INFORMS, vol. 27(1), pages 15-25, 01-02.
    4. Wakker, Peter, 1989. "Continuous subjective expected utility with non-additive probabilities," Journal of Mathematical Economics, Elsevier, vol. 18(1), pages 1-27, February.
    5. Wakker, Peter, 1990. "Characterizing optimism and pessimism directly through comonotonicity," Journal of Economic Theory, Elsevier, vol. 52(2), pages 453-463, December.
    6. Camerer, Colin F & Ho, Teck-Hua, 1994. "Violations of the Betweenness Axiom and Nonlinearity in Probability," Journal of Risk and Uncertainty, Springer, vol. 8(2), pages 167-196, March.
    7. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-291, March.
    8. George Wu & Richard Gonzalez, 1996. "Curvature of the Probability Weighting Function," Management Science, INFORMS, vol. 42(12), pages 1676-1690, December.
    9. Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, vol. 66(3), pages 497-528, May.
    10. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard H, 1990. "Experimental Tests of the Endowment Effect and the Coase Theorem," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1325-1348, December.
    11. Schmeidler, David, 1989. "Subjective Probability and Expected Utility without Additivity," Econometrica, Econometric Society, vol. 57(3), pages 571-587, May.
    12. Shefrin, Hersh & Statman, Meir, 1985. "The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence," Journal of Finance, American Finance Association, vol. 40(3), pages 777-790, July.
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    Citations

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    Cited by:

    1. Krzysztof Kontek, 2009. "Lottery valuation using the aspiration / relative utility function," Working Papers 39, Department of Applied Econometrics, Warsaw School of Economics.
    2. Emilia Tomczyk, 2013. "End of sample vs. real time data: perspectives for analysis of expectations," Working Papers 68, Department of Applied Econometrics, Warsaw School of Economics.
    3. Krzysztof Kontek & Michal Lewandowski, 2013. "Range-Dependent Utility," Working Papers 69, Department of Applied Econometrics, Warsaw School of Economics.
    4. Kontek, Krzysztof, 2010. "Multi-Outcome Lotteries: Prospect Theory vs. Relative Utility," MPRA Paper 22947, University Library of Munich, Germany.
    5. Marc Scholten & Daniel Read, 2014. "Prospect theory and the “forgotten” fourfold pattern of risk preferences," Journal of Risk and Uncertainty, Springer, vol. 48(1), pages 67-83, February.
    6. Kontek, Krzysztof, 2009. "Absolute vs. Relative Notion of Wealth Changes," MPRA Paper 17336, University Library of Munich, Germany.
    7. Ranoua Bouchouicha & Ferdinand M. Vieider, 2017. "Accommodating stake effects under prospect theory," Journal of Risk and Uncertainty, Springer, vol. 55(1), pages 1-28, August.

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    More about this item

    Keywords

    Prospect/Cumulative Prospect Theory; Markowitz Utility Hypothesis; Utility & Aspiration Functions; Mental Processes; Adaptation & Attention Focus;
    All these keywords.

    JEL classification:

    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior

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