S are called events x is a set of outcomes, a prospectis a function f. Now countless scholars are wandering in behavioral decision related with prospect theory, it is worth mentioning the prospect theory proposes daniel kahneman won the nobel prize in economics in 2002. Petersburg paradox article pdf available in economic theory 283. Click here to start building your own bibliography. The rankdependent expected utility model originally called anticipated utility is a generalized expected utility model of choice under uncertainty, designed to explain the behaviour observed in the allais paradox, as well as for the observation that many people both purchase lottery tickets implying riskloving preferences and insure against losses implying risk aversion. Cumulative prospect theory free download as pdf file. Kahnemann and tversky 1979 developed prospect theory to remedy the descriptive failures of seu theories of decision making. Cumulative representation of uncertainty, journal of risk and uncertainty, 5, 297323. On the determination of strength of belief for decision. We show that prospect theory provides a much more satisfactory account of tax evasion including an explanation of the yitzhaki puzzle. The descriptive shortcomings of classical economic models motivated the development of prospect theory d. Prospect theory prospect theory distinguishes two phases in the choice process. Prospect theory, a great decision making tool toolshero. The decision weight vi, associated with a negative outcome, is.
An analysis of decision under risk 17 daniel kahneman and arnos tversky 3 advances in prospect theory. Nonconsequential reasoning and choice 703 eldar sha. It shows that cumulative prospect theory is not merely a formal. We develop a new version of prospect theory that employs cumulative rather than separable decision weights and extends the theory in several respects. Prospect theory is a behavioral model that shows how people decide between alternatives that involve risk and uncertainty e.
Prospect theory predicts that the propensity to sell a stock declines as its price moves away from the purchase price in either direction. Cumulative prospect theory satisfies an additional property, called double matching. Cumulative representation of uncertainty amos tversky and daniel kahneman expected utility theory reigned for several decades as the dominant normative and descriptive model of decision making under uncertainty, but it has come under serious question in recent years. Journal of risk and uncertainty 5, 297323 cumulative prospect theory to tax evasion. Pdf prospect theory and investment decision behavior.
Citeseerx document details isaac councill, lee giles, pradeep teregowda. Cumulative representation of uncertainty amos tversky stanford university, department of psychology, stanford, ca 943052 1 30 daniel kahneman university of california at berkeley, department of psychology, berkeley, ca 94720 key words. In 1992, in the journal of risk and uncertainty, kahneman and tversky gave a revised account of prospect theory that they called cumulative prospect theory. Consider the decision of how much of your money to invest in the stock market. To do so, the power coefficient of an individuals utility function must be lower than the power coefficient of an individuals probability weighting function.
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 version, called cumulative prospect theory, applies to uncertain as well as to risky prospects with any number of outcomes, and it allows different weighting. We examined whether this difference would be more pronounced for prevention focus concerns. Cumulative representation of uncertainty amos tversky stanford university, department of psychology, stanford, ca 943052 daniel kahneman university of california at berkeley, department of psychology, berkeley, ca 94720 key words.
Prospect theory and the disposition effect journal of. Cumulative representation of uncertainty expected utility theory reigned for several decades as the dominant normative and descriptive model of. This version, called cumulative prospect theory, applies to uncertain as well as to risky prospects with any number of outcomes, and it allows different weighting functions for gains and for losses. The sshaped functions bring challenges, and extensions and generalizations of the nm theory into the prospect theory are not always possible. Riskhedging decisions also become more complex within the prospect. Based on behavioral economics, this paper expounds the theoretical basis of prospect theory and explains the irrational investment.
Regulatory focus effects on discounting over uncertainty. Prospect theory and the disposition effect volume 45 issue 3 markku kaustia. Cumulative or rank dependent model 43 bibliography 47. The ones marked may be different from the article in the profile. Some experiments by lola lopes are reanalyzed, and are demonstrated to favor cumulative prospect theory over prospect theory. We conclude by highlighting several applications of the theory. Prospect theory is widely viewed as the best available descriptive model of how people evaluate risk in experimental settings. Behavioral decision derived from the paradox of the expected utility theory. Tversky a, kahneman d 1992 advances in prospect theory.
Cumulative representation of uncertainty 673 amos tversky and daniel kahneman 28 thinking through uncertainty. In the stock market, influenced by information acquisition, risk preference and other factors, investors investment decision and behaviors are difficult to be fully rational, so the rational person assumption of traditional finance theory is not realistic. In handbook of the fundamentals of financial decision making. Cumulative representation of uncertainty, journal of risk and uncertainty. Its main feature was that it allowed for nonlinear probability weighting in a. Prospect theory economics bibliographies cite this for me. It demonstrates that people think in terms of expected utility relative to a reference point e. Oct 15, 2014 prospect theory is widely viewed as the best available descriptive model of how people evaluate risk in experimental settings.
Pdf risk aversion in cumulative prospect theory ulrich. It shows that cumulative prospect theory is not merely a formal correction of some theoretical problems in prospect theory, but it also gives dierent predictions. For example, in the prospect theory, the monotonicity of indifference curves depends on the underlying mean, unlike in the nm theory. On the basis of the prospect theory, tersky and kahneman 1992 12 further. The microfoundations of international relations theory. We then discuss the prospect theory model, including the value function and the probability weighting function.
Cumulative representation of uncertainty 44 arnos tversky and daniel kahneman part two. Prospect theory, indifference curves, and hedging risks. The disjunction effect in choice under uncertainty amos. With the introduction of cognitive psychology, it opened up a road for the field of behavioral decision. Uncertainty 645 chip heath and amos tversky 27 advances in prospect theory. We characterize situations in cpt where the problem can be resolved.
According to prospect theory, people are typically riskaverse with respect to gains and riskseeking with respect to losses, known as the reflection effect. It is a further development and variant of prospect theory. This version, called cumulative prospect theory, applies to uncertain as. The problem of decision making under uncertainty is described and the difficulty of comparing actions with uncertain outcomes is noted. Journal of risk and uncertainty, 5, 297323 proposes that uncertainty reduces the perceived intensity of losses slightly less than it reduces the perceived intensity of gains. S x if f is measurable with respect to a partition e i i. Advances in prospect theory cumulative representations of uncertainty.
Tversky and kahneman 1992 journal of risk and uncertainty 5. Rational decisionmaking requires you to combine your attitudes towards risk with your expectations about how the stock market will evolve in the future. Like seu theories prospect theory assumes that the value of an option or alternative is calculated as the summed products over specified outcomes. The framing phase consists of a preliminary analysis of the o ered prospects, which often yields a simpler representation of these prospects. One of the basic axioms of the rational theory of decision under uncertainty is savages 1954 surething principle stp it states that if prospect x is preferred to y knowing that event a occurred, and if x is preferred to y knowing that a did not occur, then x should be preferred to y even when it is not known whether a occurred we present examples in which the decision maker has good. This version, called cumulative prospect theory, applies to uncertain as well as to risky prospects with any number of outcomes, and it allows different weighting functions for gains.
Two principles, diminishing sensitivity and loss aversion, are invoked to explain the characteristic curvature of the value function and the. Trading data, on the other hand, show that the propensity to sell jumps at zero return, but it is approximately constant over a wide range of losses and increasing or constant over a wide range of gains. It is the founding theory of behavioral economics and of behavioral finance, and constitutes one of the first economic. The new theory eliminated the editing phase in prospect theory and focused just on the evaluation phase. C u m u lative representation of uncertainty a m o s t v e r s k y stanford u niversity, department o f psychology, stanford, c a 943052 d a n ie l k a h n e m a n u niversity o f california a t berkeley, department o f p sychology, berkeley, c a 94720. We present a number of empirical demonstrations that are inconsistent with the classical theory, expected utility, but can be explained by prospect theory. Cumulative representation of uncertainty altmetric badge. The program calculates the value of prospects with no more than four outcomes under cumulative prospect theory cpt, the theory introduced by. Finally, we fit the ladder data with weighting functions proposed by tversky and kahneman tversky, amos, daniel kahneman. Prospect theory attempts to describe and explain decisions under uncertainty. The framing of decisions and the psychology of choice 41 4. C u m u lative representation of uncertainty a m o s t v e r s k y stanford u niversity, department o f psychology, stanford, c a 943052 d a n ie l k a h n e m a n u niversity o f california a t berkeley, department o f p sychology, berkeley, c a 94720 key w o rd s.
We discuss the role of valuation functions which convert an uncertain outcome into a single representative value and hence aid in the comparison of uncertain alternatives. Program for calculating the cumulativeprospecttheory value. A discussion of empirical dierences hein fennema university of nijmegen, the netherlands peter wakker university of leiden, the netherlands abstract this paper discusses dierences between prospect theory and cumulative prospect theory. In their 1992 paper, kahneman and tversky developed an updated form of prospect theory, which they termed cumulative prospect theory. This cited by count includes citations to the following articles in scholar. A cognitive perspective 729 daniel kahneman and amos tversky. The theory incorporates rankdependent functionals which transform cumulative, rather than individual probabilities, in response to a growing literature, and satisfies stochastic dominance, which the original form of prospect theory.
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