scholarly journals A Tractable Method to Measure Utility and Loss Aversion under Prospect Theory

2007 ◽  
Author(s):  
Mohammed Abdellaoui ◽  
Han Bleichrodt ◽  
Olivier l'Haridon
Keyword(s):  
Prospect Theory ◽  
Loss Aversion

scholarly journals Cumulative prospect theory and deferred annuities

2019 ◽  
Vol 11 (3) ◽  
pp. 277-293 ◽  
Author(s):  
Anran Chen ◽  
Steven Haberman ◽  
Stephen Thomas
Keyword(s):  
Prospect Theory ◽  
Loss Aversion ◽  
Design Methodology ◽  
Behavioral Model ◽  
Cumulative Prospect Theory ◽  
Optimal Consumption ◽  
Content Type ◽  
Deferred Annuity ◽  
To Receive

Purpose Although it has been proved theoretically that annuities can provide optimal consumption during one’s retirement period, retirees’ reluctance to purchase annuities is a long-standing puzzle. The purpose of this paper is to use behavioral model to analyze the low demand for immediate annuities. Design/methodology/approach The authors employ cumulative prospect theory (CPT), which contains both loss aversion and probability transformations, to analyze the annuity puzzle. Findings The authors show that CPT can explain the unattractiveness of immediate annuities. It also shows that retirees would be willing to buy a long-term deferred annuity at retirement. By considering each component from CPT in turn, the loss aversion is found to be the major reason that stops people from buying an annuity while the survival rate transformation is an important factor affecting the decision of when to receive annuity incomes. Originality/value This paper identifies CPT as one of the reasons for the low demand of immediate annuities. It further suggests that long-term deferred annuities could overcome behavioral obstacles and become popular among retirees.

Loss Aversion on the Links

2016 ◽  
Vol 5 (4) ◽  
pp. 24-40
Author(s):  
Todd A. McFall
Keyword(s):  
Prospect Theory ◽  
Loss Aversion ◽  
Utility Level ◽  
Relative Standing

Prospect theory predicts that loss averse agents who fear they will not reach their reference utility level are more apt to adopt risky strategies to avoid that painful possibility compared to agents who are more sure of their relative standing. This paper tests this theory with data from professional golf events and finds evidence of economically inefficient loss aversion amongst tournament competitors. While playing par five holes, golfers who have been penalized because of a poor first shot are more likely to adopt an aggressive strategy for finishing the hole compared to their non-penalized rivals who are not feeling the burden of not meeting a preconceived reference score. The risks the penalized golfers take are economically inefficient, as their average performances are worse than their non-penalized rivals' average performances for the balance of the hole.

Prospect Theory and Foreign Policy Analysis

2017 ◽  
Author(s):  
Jeffrey W. Taliaferro
Keyword(s):  
Decision Making ◽  
Foreign Policy ◽  
Policy Analysis ◽  
Prospect Theory ◽  
Loss Aversion ◽  
Reference Point ◽  
Endowment Effect ◽  
Risk Averse ◽  
Foreign Policy Analysis ◽  
Point Selection

Prospect theory is one of the most influential behavioral theories in the international relations (IR) field, particularly among scholars of security studies, political psychology, and foreign policy analysis. Developed by Israeli psychologists Daniel Kahneman and Amos Tversky, prospect theory provides key insights into decision making under conditions of risk and uncertainty. For example, most individuals are risk averse to secure gains, but risk acceptant to avoid losses (loss aversion). In addition, most people value items they already posses more than they value items they want to acquire (endowment effect), and tend to be risk averse if they perceive themselves to be facing gains relative to their reference point (risk propensity). Prospect theory has generated an enormous volume of scholarship in IR, which can be divided into two “generations”. The first generation (1990–1999) sought to establish prospect theory’s plausibility in the “real world” by testing hypotheses derived from it against subjective expected-utility theory or rational choice models of foreign policy decision making. The second generation (2000–present) began to incorporate concepts associated with prospect theory and related experimental literature on group risk taking into existing mid-level theories of IR and foreign policy behavior. Two substantive areas covered by scholars during this period are coercive diplomacy and great power intervention in the periphery as they relate to loss aversion. Both generations of prospect theory literature suffer from conceptual and methodological difficulties, mainly around the issues of reference point selection, framing, and preference reversal outside laboratory settings.

Humans, Econs and Portfolio Choice

2016 ◽  
Vol 07 (02) ◽  
pp. 1750001 ◽  
Author(s):  
Michael J. Best ◽  
Robert R. Grauer
Keyword(s):  
Prospect Theory ◽  
Portfolio Choice ◽  
Loss Aversion ◽  
Asset Allocation ◽  
Power Utility ◽  
Numerical Example ◽  
Portfolio Choices ◽  
Out Of Sample ◽  
Finance Theory ◽  
Mean Variance

We compare the portfolio choices of Humans — prospect theory investors — to the portfolio choices of Econs — power utility and mean-variance (MV) investors. In a numerical example, prospect theory portfolios are decidedly unreasonable. In an in-sample asset allocation setting, the prospect theory results are consistent with myopic loss aversion. However, the portfolios are extremely unstable. The power utility and MV results are consistent with traditional finance theory, where the portfolios are stable across decision horizons. In an out-of-sample asset allocation setting, the power utility and portfolios outperform the prospect theory portfolios. Nonetheless the prospect theory portfolios with loss aversion coefficients of 2.25 and 2 perform well.

scholarly journals Exchange Asymmetries Incorrectly Interpreted as Evidence of Endowment Effect Theory and Prospect Theory?

2007 ◽  
Vol 97 (4) ◽  
pp. 1449-1466 ◽  
Author(s):  
Charles R Plott ◽  
Kathryn Zeiler
Keyword(s):  
Utility Function ◽  
Prospect Theory ◽  
Loss Aversion ◽  
Alternative Explanation ◽  
Endowment Effect ◽  
Effect Theory

Systematic asymmetries in exchange behavior have been widely interpreted as support for “endowment effect theory,” an application of prospect theory positing that loss aversion and utility function kinks set by entitlements explain observed asymmetries. We experimentally test an alternative explanation, namely, that asymmetries are explained by classical preference theories finding influence through the experimental procedures typically used. Contrary to the predictions of endowment effect theory, we observe no asymmetries when we modify procedures to remove the influence of classical preference theories. When we return to traditional-type procedures, however, the asymmetries reappear. The results support explanations based in classical preference theories and reject endowment effect theory. (JEL D01)

The Boundaries of Loss Aversion

2005 ◽  
Vol 42 (2) ◽  
pp. 119-128 ◽  
Author(s):  
Nathan Novemsky ◽  
Daniel Kahneman
Keyword(s):  
Risk Aversion ◽  
Prospect Theory ◽  
Loss Aversion ◽  
Equal Probability ◽  
Preliminary Support ◽  
Complete Account

In this article, the authors propose some psychological principles to describe the boundaries of loss aversion. A key idea is that exchange goods that are given up “as intended” do not exhibit loss aversion. For example, the authors propose that money given up in purchases is not generally subject to loss aversion. The results of several experiments provide preliminary support for the hypotheses. The authors find that, consistent with prospect theory, loss aversion provides a complete account of risk aversion for risks with equal probability to win or lose. The authors propose boundaries for this result and suggest further tests of the model.

scholarly journals Loss aversion does disappear and reverse, although estimates of lambda (λ) are not reliable: Reply to André and De Langhe

2020 ◽  
Author(s):  
Lukasz Walasek ◽  
Timothy L Mullett ◽  
Neil Stewart
Keyword(s):  
Prospect Theory ◽  
Measurement Invariance ◽  
Loss Aversion ◽  
Choice Data ◽  
General Issue ◽  
Choice Proportion ◽  
Choice Sets ◽  
The Common ◽  
Gains And Losses

Walasek and Stewart (2015) demonstrated that loss aversion estimated from fitting accept-reject choice data from a set of 50/50 gambles can be made to disappear or even reverse by manipulating the range of gains and losses experienced in different conditions. André and de Langhe (2020) critique this conclusion because in estimating loss aversion on different choice sets, Walasek and Stewart (2015) have violated measurement invariance. They show, and we agree, that when loss aversion is estimated on the choices common to all conditions there is no difference in prospect theory’s λ parameter. But there are two problems here. First, while there are no differences in λs across conditions, there are very large differences in the proportion of the common gambles that are accepted, which André and de Langhe chose not to report. These choice proportion differences are consistent with decision by sampling (but are inconsistent with prospect theory or any of the alternative mechanisms proposed by André and de Langhe, 2020). Second, we demonstrate a much more general issue related to the issue of measurement invariance: that λ estimated from the accept-reject choices is extremely unreliable and does not generalise even across random splits within large, balanced choice sets. It is therefore not possible to determine whether differences in choice proportions are due to loss aversion or to a bias in accepting or rejecting mixed gambles. We conclude that context has large effects on the acceptance of mixed gambles and that it is futile to estimate λ from accept-reject choices.

Law’s Loss Aversion

2014 ◽  
pp. 267-299 ◽  
Author(s):  
Eyal Zamir
Keyword(s):  
Consumer Behavior ◽  
Behavioral Economics ◽  
Prospect Theory ◽  
Loss Aversion ◽  
Legal Theory ◽  
Burden Of Proof ◽  
Psychological Literature ◽  
The Law ◽  
Basic Features ◽  
Default Rules

Kahneman and Tversky’s prospect theory is probably the most influential contribution to behavioral economics, and loss aversion is the most important element of this theory: Losses loom larger than gains. This chapter surveys the effect this notion has had on legal theory. It first provides an overview of the vast psychological literature on loss aversion. It then demonstrates the contribution made by studies of loss aversion in several contexts that are of particular interest to the law, including consumer behavior and litigation and settlement. The chapter further discusses the possibility of triggering loss aversion through legal framing, focusing on two examples: default rules and burden of proof. It also suggests that there is a striking correspondence between loss aversion and basic features of the law, and offers possible explanations for this correspondence. Finally, the chapter briefly discusses some of the normative implications of loss aversion for the law.

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