Inefficient Reallocation, Loss Aversion and Prospect Theory

S. Ungureanu

Working Papers from Department of Economics, City University London

Abstract: The paper shows that bounded rationality, in the form of limited knowledge of utility, is an explanation for common stylized facts of prospect theory like loss aversion, status quo bias and non-linear probability weighting. Locally limited utility knowledge is considered within a classical demand model framework, suggesting that costs of inefficient search for optimal consumption will produce a value function that obeys the loss aversion axiom of Tversky and Kahneman (1991). Moreover, since this adjustment happens over time, new predictions are made that explain why the status quo bias is reinforced over time. This search can also describe the behavior of a consumer facing an uncertain future wealth level. The search cost justifies non-linear forms of probability weighting. The effects that have been observed in experiments will follow as a consequence.

Keywords: status quo bias; reference dependence; loss aversion; cost of choice; search costs; probability weighting; transaction costs; bounded rationality. (search for similar items in EconPapers)
Date: 2015-01-15
New Economics Papers: this item is included in nep-cbe and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed

Downloads: (external link)
https://openaccess.city.ac.uk/id/eprint/8124/1/Ine ... 20Ungureanu_1501.pdf

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: https://EconPapers.repec.org/RePEc:cty:dpaper:8124

Access Statistics for this paper

More papers in Working Papers from Department of Economics, City University London Department of Economics, Social Sciences Building, City University London, Whiskin Street, London, EC1R 0JD, United Kingdom,. Contact information at EDIRC.
Bibliographic data for series maintained by Research Publications Librarian ().