Absolute vs. Relative Notion of Wealth Changes

Krzysztof Kontek ()

MPRA Paper from University Library of Munich, Germany

Abstract: This paper discusses solutions derived from lottery experiments using two alternative assumptions: that people perceive wealth changes as absolute amounts of money; and that people consider wealth changes as a proportion of some reference value dependant on the context of the problem under consideration. The former assumption leads to the design of Prospect Theory, the latter - to a solution closely resembling the utility function hypothesized by Markowitz (1952B). This paper presents several crucial arguments for the latter approach. That essentially all financial theories consider “returns” expressed in relative terms, rather than “gains” and “losses” expressed as monetary amounts, is one of them. This provides arguments for rejecting the Prospect Theory paradigm.

Keywords: Prospect / Cumulative Prospect Theory; Probability Weighting Function; Markowitz Hypothesis; Weber’s Law (search for similar items in EconPapers)
JEL-codes: D03 D81 D01 D87 C91 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cbe, nep-neu and nep-upt
Date: 2009-09-16
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http://mpra.ub.uni-muenchen.de/17336/ orginal version
http://mpra.ub.uni-muenchen.de/29764/ revised version
http://mpra.ub.uni-muenchen.de/33134/ revised version

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Persistent link: http://EconPapers.repec.org/RePEc:pra:mprapa:17336

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