Non-Monotonicity of the Tversky-Kahneman Probability-Weighting Function: A Cautionary Note

Jonathan Ingersoll

Yale School of Management Working Papers from Yale School of Management

Abstract: Cumulative Prospect Theory (CPT) has been used in a wide variety of economic models as an alternative to Expected Utility Theory (EUT). It is used to account for a number of anomalies in the observed behavior of economic agents. Like EUT, CPT uses a utility or value function to rate any given outcome. In CPT, however, the utility function is loss averse SS-shaped) rather than risk averse (concave). The other difference between the two theories is the use of decision weights rather than probabilities in computing the expectation. This note provides a caution on the use of a popular form of decision weights - those proposed by Tversky and Kahneman (1992) in their introduction of the theory. In particular, the weights generated by their proposed probability weighting function can be negative for some parameter values. This could lead to evaluations that chose first-order stochastically dominated gambles rather than the dominating one. The parameter values that can cause such problems are small relative to estimated values. Nevertheless, failure to recognize this problem may prevent the proofs of some theorems or allow the proof of some theorems which would be invalid with properly restricted probability weights.

Keywords: Tversky-Kahneman; Probability Weighting; Cumulative Prospect Theory; economic models; Expected Utility Theory Working Paper Series (search for similar items in EconPapers)
Date: 2007-10-01, Revised 2007-11-01
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://repec.som.yale.edu/icfpub/publications/2432.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ysm:wpaper:amz2432

Access Statistics for this paper

More papers in Yale School of Management Working Papers from Yale School of Management Contact information at EDIRC.
Bibliographic data for series maintained by ().