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Foundations of the Rank-Dependent Probability Weighting Function

Matthew Rablen

No 12701, IZA Discussion Papers from Institute of Labor Economics (IZA)

Abstract: The psychological basis for rank-dependent probability weighting, and for an inverse-S probability weighting function (PWF) in particular, has often been questioned. I examine the existence and shape of the PWF in a model allowing for optimism/pessimism over probability distributions and for loss averse/gain loving stochastic reference dependence. I give commonly observed shapes of PWF a psychological interpretation. In particular, I establish a deep connection between two of the most established phenomena in decisionmaking: loss aversion and the inverse-S PWF: the former is a pre- condition for the latter.

Keywords: probability weighting; rank dependent expected utility; loss aversion; reference dependence; optimism; pessimism (search for similar items in EconPapers)
JEL-codes: D01 D81 (search for similar items in EconPapers)
Pages: 20 pages
Date: 2019-10
New Economics Papers: this item is included in nep-cbe, nep-ore and nep-upt
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