Loss Aversion, Risk Aversion, and the Shape of the Probability Weighting Function

Matthew Rablen

No 10491, CESifo Working Paper Series from CESifo

Abstract: Loss aversion, risk aversion, and the probability weighting function (PWF) are three central concepts in explaining decisionmaking under risk. I examine interlinkages between these concepts in a model of decisionmaking that allows for loss averse/tolerant stochastic reference dependence and optimism/pessimism over probability distributions. I give a preference interpretation to commonly observed shapes of PWF and to risk aversion. In particular, I establish a connection between loss aversion and both risk aversion and the inverse-S PWF: loss aversion is a necessary condition to observe each of these phenomena. The results extend to distinct PWFs in the gain and loss domains, as under prospect theory.

Keywords: probability weighting; rank dependent expected utility; loss aversion; risk aversion; reference dependence; optimism; pessimism; prospect theory (search for similar items in EconPapers)
JEL-codes: D01 D81 D91 (search for similar items in EconPapers)
Date: 2023
New Economics Papers: this item is included in nep-cbe, nep-rmg and nep-upt
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Working Paper: Loss Aversion, Risk Aversion, and the Shape of the Probability Weighting Function (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_10491

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