A Satiscing Alternative to Prospect Theory

David B. Brown, Enrico De Giorgi () and Melvyn Sim
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David B. Brown: Fuqua School of Business, Duke University
Melvyn Sim: NUS Business School, NUS Risk Management Institute, National University of Singapore

No 09-19, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: In this paper, we axiomatize a target-based model of choice that allows decision makers to be both risk averse and risk seeking, depending on the payoff's position relative to a pre- specified target. The approach can be viewed as a hybrid model, capturing in spirit two celebrated ideas: first, the satisficing concept of Simon (1955); second, the switch between risk aversion and risk seeking popularized by the prospect theory of Kahneman and Tversky (1979). Our axioms are simple and intuitive; in order to be implemented in practice, our approach requires only the specification of an aspiration level. We show that this approach is dual to a known approach using risk measures, thereby allowing us to connect to existing theory. Though our approach is intended to be normative, we also show that it resolves the classical paradoxes of Allais (1953) and Ellsberg (1961), neither of which can be explained by expected utility theory.

Keywords: satisficing; aspiration levels; targets; prospect theory; reflection effect; risk measures; convex risk measures; portfolio optimization. (search for similar items in EconPapers)
JEL-codes: D81 G11 (search for similar items in EconPapers)
Pages: 63 pages
Date: 2009-05
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp0919

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