Gain-Loss Hedging and Cumulative Prospect Theory

Lorenzo Bastianello, Alain Chateauneuf and Bernard Cornet
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Lorenzo Bastianello: Universite Paris 2 Pantheon-Assas, LEMMA, Paris, France
Alain Chateauneuf: IPAG Business School, Paris, France and Paris School of Economics and Universite Paris 1, Paris, France
Bernard Cornet: Department of Economics, University of Kansas, Lawrence, KS 66045, USA

No 202511, WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS from University of Kansas, Department of Economics

Abstract: Two acts are comonotonic if they co-vary in the same direction. The main purpose of this paper is to derive a new characterization of Cumulative Prospect Theory (CPT) through simple properties involving comonotonicity. The main novelty is a concept dubbed gain-loss hedging: mixing positive and negative acts creates hedging possibilities even when acts are comonotonic. This allows us to clarify in which sense CPT differs from Choquet expected utility. Our analysis is performed under the assumption that acts are real-valued functions. This entails a simple (piece-wise) constant marginal utility representation of CPT, which allows us to clearly separate the perception of uncertainty from the evaluation of outcomes.

Keywords: Cumulative Prospect Theory; Comonotonicity; Gain-loss hedging; Sipos integral; Choquet integral. (search for similar items in EconPapers)
JEL-codes: D81 (search for similar items in EconPapers)
Date: 2025-04
New Economics Papers: this item is included in nep-upt
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