It is Whether You Win or Lose: The Importance of the Overall Probabilities of Winning or Losing in Risky Choice

John Payne ()

Journal of Risk and Uncertainty, 2005, vol. 30, issue 1, 5-19

Abstract: Imagine that you own a five-outcome gamble with the following payoffs and probabilities: ($100, .20; $50, .20; $0, .20; −$25, .20; −$50, .20). What happens when the opportunity to improve such a gamble is provided by a manipulation that adds value to one outcome versus another outcome, particularly when the opportunity to add value to one outcome versus another outcome changes the overall probability of a gain or the overall probability of a loss? Such a choice provides a simple test of the expected utility model (EU), original prospect theory (OPT), and cumulative prospect theory (CPT). A study of risky choices involving 375 respondents indicates that respondents were most sensitive to changes in outcome values that either increased the overall probability of a strict gain or decreased the overall probability of a strict loss. These results indicate more support for OPT rather than CPT and EU under various assumptions about the shape of the utility and value and weighting functions. Most importantly, the main difference between the various expectation models of risky choice occurs for outcomes near the reference value. A second study of risky choice involving 151 respondents again demonstrated the sensitivity of subjects to reducing the probability of a strict loss even at the cost of reduced expected value. Consequently, we argue that theories of how people choose among gambles that involve three or more consequences with both gains and losses need to include measures of the overall probabilities of a gain and of a loss. Copyright Springer Science + Business Media, Inc. 2005

Keywords: decision; risk; preference (search for similar items in EconPapers)
Date: 2005
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Citations: View citations in EconPapers (51)

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DOI: 10.1007/s11166-005-5831-x

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