LOSS AVERSION AND RUINOUS OPTIMAL WAGERS IN CUMULATIVE PROSPECT THEORY

David Peel and David Law ()
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David Law: University of Bangor

Economics Bulletin, 2017, vol. 37, issue 1, 352-360

Abstract: We demonstrate that extant parametric specifications of Cumulative Prospect Theory exhibit counterfactual implications for optimal wagers at actuarially unfair odds. In particular they imply individuals may maximizes their utility, called value function in Cumulative Prospect Theory, by wagering all or large proportions of their wealth on actuarially unfair gambles. In order to eliminate this property it is necessary that loss aversion is unbounded and increases as stake size increases. We present new parametric specifications of the value function over losses that exhibit this feature and therefore eliminate the ruinous wagering property

Keywords: Cumulative Prospect Theory; Loss Aversion; Optimal Wagering (search for similar items in EconPapers)
JEL-codes: B4 (search for similar items in EconPapers)
Date: 2017-02-22
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