Gain–loss hedging and cumulative prospect theory

Lorenzo Bastianello, Alain Chateauneuf and Bernard Cornet

Mathematical Social Sciences, 2024, vol. 131, issue C, 40-47

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; Šipoš integral; Choquet integral (search for similar items in EconPapers)
Date: 2024
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Working Paper: Gain-Loss Hedging and Cumulative Prospect Theory (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:matsoc:v:131:y:2024:i:c:p:40-47

DOI: 10.1016/j.mathsocsci.2024.07.003

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