An Alternative to Prospect Theory

Liang Zou
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Liang Zou: University of Amsterdam Business School

Annals of Economics and Finance, 2006, vol. 7, issue 1, 1-28

Abstract: This paper presents a new approach to decision-making under risk. Preference over risky prospects is defined as a triadic reference-dependent relation in a sense similar to Sugden (2003). Characterized by a set of von Neumann-Morgenstern-style axioms, a new reference-dependent representation theory ¨C called compound utility theory (CUT) ¨C is obtained which accommodates nonlinear preferences (in probabilities) without invoking the probability-transformation assumption of cumulative prospect theory. Given any opportunity set, a unique reference level can be identified which is consistent with CUT and which enables one to study preferences over both relative changes and absolute levels of wealth simultaneously.

Keywords: Expected utility theory; Cumulative prospect theory; Compound utility theory; Reference-dependence; Nonlinear preference; Triadic preference relation; Utility-reward; Disutility-risk (search for similar items in EconPapers)
JEL-codes: D81 (search for similar items in EconPapers)
Date: 2006
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:cuf:journl:y:2006:v:7:i:1:p:1-28

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