Are People Really Risk Seeking for Losses?
This short paper demonstrates that the claim of Cumulative Prospect Theory (CPT) that people are risk seeking for loss prospects, which confirmed a hypothetical assumption of the earlier Prospect Theory (PT), appears to be merely a result of using a specific form of the probability weighting function to estimate the power factor of the value function. Using experimental data and the form of the probability weighting function presented by CPT gives a power factor for losses of less than 1. This would mean that people are risk seeking for loss prospects. However, once more flexible, two-parameter forms are used, the power factor takes on values between 1.04 and 1.10. This, however, makes the value function convex, which indicates risk aversion. It follows that people are generally risk averse both for gains and for losses. This contradicts one of the main theses of Prospect Theory.
|Date of creation:||14 Dec 2009|
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- Kahneman, Daniel & Tversky, Amos, 1979.
"Prospect Theory: An Analysis of Decision under Risk,"
Econometric Society, vol. 47(2), pages 263-91, March.
- Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
- Tversky, Amos & Kahneman, Daniel, 1992. "Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
- Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, vol. 66(3), pages 497-528, May.
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