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The utility function under Prospect Theory

By Ali al-Nowaihi, Ian Bradley and Sanjit Dhami


Prospect theory is the main behavioral alternative to expected utility. Tversky\ud and Kahnemann (1992) motivate the utility function for gains and losses under\ud prospect theory by using the axiom of preference homogeneity. However, they do not\ud provide the formal proof. We provide the relevant proof. Furthermore, we show that\ud the utility function under preference homogeneity obeys an additional and important\ud restriction that is not noted by Tversky and Kahnemann (1992). This simplifies the\ud use of prospect theory by reducing the number of free parameters by one

Topics: Prospect Theory, Preference homogeneity, Functional equations.
Publisher: Dept. of Economics, University of Leicester
Year: 2006
OAI identifier: oai:lra.le.ac.uk:2381/7453

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