Loss Aversion, Risk Aversion, and the Shape of the Probability Weighting Function

Matthew Rablen

No 2023013, Working Papers from The University of Sheffield, Department of Economics

Abstract: Loss aversion, risk aversion, and the probability weighting function (PWF) are three central concepts in explaining decision making under risk. I examine interlinkages be- tween these concepts in a model of decision making that allows for loss averse/tolerant stochastic reference dependence and optimism/pessimism over probability distribu- tions. I give a preference interpretation to commonly observed shapes of PWF and to risk aversion. In particular, I establish a connection between loss aversion and both risk aversion and the inverse-S PWF: loss aversion is a necessary condition to observe each of these phenomena. The results extend to distinct PWFs in the gain and loss domains, as under prospect theory.

Keywords: Probability Weighting; Rank Dependent Expected Utility; Loss Aversion; Risk Aversion; Reference Dependence; Optimism; Pessimism; Prospect Theory (search for similar items in EconPapers)
JEL-codes: D01 D81 D91 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2023-06
New Economics Papers: this item is included in nep-rmg and nep-upt
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https://www.sheffield.ac.uk/economics/research/serps First version, June 2 2023 (application/pdf)

Related works:
Working Paper: Loss Aversion, Risk Aversion, and the Shape of the Probability Weighting Function (2023)
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