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Separating attitudes towards money from attitudes towards probabilities: Stake effects and ambiguity as a test for prospect theory

Author

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  • Vieider, Ferdinand M.
  • Cingl, Lubomír
  • Martinsson, Peter
  • Stojic, Hrvoje

Abstract

Prospect theory (PT) is the dominant descriptive theory of decision making under risk today. For the modeling of choices, PT relies on a psychologically founded separation of risk attitudes into attitudes towards outcomes, captured in a value function; and attitudes towards probabilities, captured in a probability weighting function. However, while it is theoretically sound, it is unclear whether this clear separation is reflected in actual choices. To test this, we designed two experiments. In the first experiment, we elicit the value and probability weighting functions both under known and unknown probabilities. The results support PT and show that the value function is unaffected by the nature of the probabilities, which only affects probability weighting. More in general, this finding supports theories that represent ambiguity attitudes through probability transformations rather than utility transformations. In the second experiment, we examine the effects of an increase in stakes on risk attitudes. We find that the stake increase is not reflected in the value function, but rather in the weighting function, thus contradicting PT's prediction.

Suggested Citation

  • Vieider, Ferdinand M. & Cingl, Lubomír & Martinsson, Peter & Stojic, Hrvoje, 2013. "Separating attitudes towards money from attitudes towards probabilities: Stake effects and ambiguity as a test for prospect theory," Discussion Papers, WZB Junior Research Group Risk and Development SP II 2013-401, Social Science Research Center Berlin (WZB).
  • Handle: RePEc:zbw:wzbrad:spii2013401
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    References listed on IDEAS

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    1. Hans-Martin von Gaudecker & Arthur van Soest & Erik Wengstrom, 2011. "Heterogeneity in Risky Choice Behavior in a Broad Population," American Economic Review, American Economic Association, pages 664-694.
    2. Mohammed Abdellaoui & Han Bleichrodt & Olivier L'Haridon & Dennie Van Dolder, 2013. "Source-Dependence of Utility and Loss Aversion: A Critical Test of Ambiguity Models," Economics Working Paper Archive (University of Rennes 1 & University of Caen) 201330, Center for Research in Economics and Management (CREM), University of Rennes 1, University of Caen and CNRS.
    3. Guido Baltussen & G. Post & Martijn Assem & Peter Wakker, 2012. "Random incentive systems in a dynamic choice experiment," Experimental Economics, Springer;Economic Science Association, vol. 15(3), pages 418-443, September.
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    Cited by:

    1. Mohammed Abdellaoui & Han Bleichrodt & Olivier L’Haridon & Dennie Dolder, 2016. "Measuring Loss Aversion under Ambiguity: A Method to Make Prospect Theory Completely Observable," Journal of Risk and Uncertainty, Springer, vol. 52(1), pages 1-20, February.

    More about this item

    Keywords

    prospect theory; value functions; probability weighting; risk attitudes; ambiguity aversion; modeling of preferences;

    JEL classification:

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

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