Economics at your fingertips  

Losses loom larger than gains and reference dependent preferences in Bernoulli’s utility function

Charles-Cadogan, G.

Journal of Economic Behavior & Organization, 2018, vol. 154, issue C, 220-237

Abstract: Some analysts claim that Bernoulli’s utility function is “reference-independent”, so it is not able to generate a loss aversion index, and that the theoretical framework of Prospect Theory (PT) is required to achieve those results. This paper examines that claim and finds that the geometry of Bernoulli’s original utility function specification either explains or implies key elements of PT: reference dependence and a loss aversion index. Theory and evidence show that the loss aversion index constructed from reference wealth in Bernoulli’s utility specification is in the domain of attraction of a stable law. That is, its distribution is a slow varying function with a fat tail that decays like a power law. Additionally, the index can be tested with a modified Fisher z-transform test. Bernoulli‘s utility function also sheds light on why loss aversion may be over-estimated under PT. In a nutshell, Bernoulli’s utility function is alive and well.

Keywords: Prospect theory; Bernoulli utility; Loss aversion; Fisher z-transform test; Stable distribution; Fat tail (search for similar items in EconPapers)
JEL-codes: C0 D03 D81 (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations Track citations by RSS feed

Downloads: (external link)
Full text for ScienceDirect subscribers only

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:

Access Statistics for this article

Journal of Economic Behavior & Organization is currently edited by Neilson, William Stuart

More articles in Journal of Economic Behavior & Organization from Elsevier
Bibliographic data for series maintained by Dana Niculescu ().

Page updated 2018-12-08
Handle: RePEc:eee:jeborg:v:154:y:2018:i:c:p:220-237