1,435 research outputs found

    Measuring loss aversion under ambiguity: a method to make prospect theory completely observable

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    We propose a simple, parameter-free method that, for the first time, makes it possible to completely observe Tversky and Kahneman’s (1992) prospect theory. While methods exist to measure event weighting and the utility for gains and losses separately, there was no method to measure loss aversion under ambiguity. Our method allows this and thereby it can measure prospect theory’s entire utility function. Consequently, we can properly identify properties of utility and perform new tests of prospect theory. We implemented our method in an experiment and obtained support for prospect theory. Utility was concave for gains and convex for losses and there was substantial loss aversion. Both utility and loss aversion were the same for risk and ambiguity, as assumed by prospect theory, and sign-comonotonic trade-off consistency, the central condition of prospect theory, held

    Additive utility in prospect theory

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    Prospect theory is currently the main descriptive theory of decision under uncertainty. It generalizes expected utility by introducing nonlinear decision weighting and loss aversion. A difficulty in the study of multiattribute utility under prospect theory is to determine when an attribute yields a gain or a loss. One possibility, adopted in the theoretical literature on multiattribute utility under prospect theory, is to assume that a decision maker determines whether the complete outcome is a gain or a loss. In this holistic evaluation, decision weighting and loss aversion are general and attribute-independent. Another possibility, more common in the empirical literature, is to assume that a decision maker has a reference point for each attribute. We give preference foundations for this attribute-specific evaluation where decision weighting and loss aversion are depending on the attributes

    A Parametric Analysis of Prospect Theory's Functionals for the General Population

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    This paper presents the results of an experiment that completely measures the utility function and probability weighting function for different positive and negative monetary outcomes, using a representative sample of N = 1935 from the general public. The results confirm earlier findings in the lab, suggesting that utility is less pronounced than what is found in classical measurements where expected utility is assumed. Utility for losses is found to be convex, consistent with diminishing sensitivity, and the obtained loss aversion coefficient of 1.6 is moderate but in agreement with contemporary evidence. The estimated probability weighing functions have an inverse-S shape and they imply pessimism in both domains. These results show that probability weighting is also an important phenomenon in the general population. Women and lower educated individuals are found to be more risk averse, in agreement with common findings. Unlike previous studies that ascribed gender differences in risk attitudes solely to differences in the degree utility curvature, however, our results show that this finding is primarily driven by loss aversion and, for women, also by a more pessimistic psychological response towards the probability of obtaining the best possible outcome.loss aversion, utility for gains and losses, prospect theory, subjective probability weighting

    The shape of the utility function under risk in the loss domain and the "ruinous losses" hypothesis: some experimental results

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    This paper reports some preliminary experimental results as regards the shape of the utility function for losses when elicited over a wide interval of consequences. Individual utility functions are elicited using the trade-off method, which, unlike standard elicitation procedures, is robust to probability weighting (and avoids most cognitive biases). Even though most utility functions exhibit the usual convex shape, nearly 25% of them appear to be inverse-S shaped, with convexity over moderate losses changing to concavity as losses grow. Though not conclusive (due mainly to the small size of our subject pool), this result brings some new support to the old idea that ruinous or unacceptable losses may induce some abrupt change in the shape of the utility function. Most importantly, it paves the way for more systematic investigation of the "ruinous losses" hypothesis.utility under risk, large losses, ruin, trade-off method, individual decision making under risk

    A Parametric Analysis of Prospect Theory's Functionals for the General Population

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    This paper presents the results of an experiment that completely measures the utility function and probability weighting function for different positive and negative monetary outcomes, using a representative sample of N = 1935 from the general public. The results confirm earlier findings in the lab, suggesting that utility is less pronounced than what is found in classical measurements where expected utility is assumed. Utility for losses is found to be convex, consistent with diminishing sensitivity, and the obtained loss aversion coefficient of 1.6 is moderate but in agreement with contemporary evidence. The estimated probability weighing functions have an inverse-S shape and they imply pessimism in both domains. These results show that probability weighting is also an important phenomenon in the general population. Women and lower educated individuals are found to be more risk averse, in agreement with common findings. Unlike previous studies that ascribed gender differences in risk attitudes solely to differences in the degree utility curvature, however, our results show that this finding is primarily driven by loss aversion and, for women, also by a more pessimistic psychological response towards the probability of obtaining the best possible outcome.prospect theory, utility for gains and losses, loss aversion, subjective probability weighting

    Intertemporal Tradeoffs for Gains and Losses: An Experimental Measurement of Discounted Utility

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    This paper is the first to measure utility in intertemporal choice and presents new and more robust evidence on the discounting of money outcomes. Our measurement method is parameterfree in the sense that it requires no assumptions about utility or discounting. We found that intertemporal utility was concave for gains and convex for losses, consistent with a hypothesis put forward by Loewenstein and Prelec (1992). Utility in intertemporal choice was close to utility in decision under risk and uncertainty, suggesting that there may be one unifying concept of utility that applies to all of economics. The existence of one concept of utility is important for applied economics, because it largely reduces data requirements. Discount rates declined over time, but less so than has been observed in previous studies that assumed linear utility. Of the main discounted utility models, Loewenstein and Prelec’s (1992) generalized hyperbolic discounting model best fitted our data. The widely-used quasi-hyperbolic model fitted the data only slightly better than constant discounting. Finally, we obtained evidence of an asymmetry in discounting between gains and losses, which, in contrast with earlier findings, cannot be explained by a framing effect

    Beliefs, Preferences and Health Insurance Behavior

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    Beliefs, Preferences and Health Insurance Behavior

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    The Case for Limited Auditor Liability - The Effects of Liability Size on Risk Aversion and Ambiguity Aversion

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    Both the US and the EU consider limiting auditor liability in order to ensure the viability of the audit market, but fear its potentially negative impact on audit quality. Our paper discusses the existing empirical results on this topic in the auditing and behavioral economics literature, and provides new evidence based on a controlled laboratory experiment. Our experiment involves real losses and allows for direct inference of behaviour under limited and unlimited liability in situations of ambiguous liability risk. Our findings imply that limited liability can induce an efficient level of audit effort, while unlimited liability induces an inefficiently high level of audit effort. This paper contributes to the literature on auditor liability, as well behavioral economics research in general, by addressing recent controversial issues on behavior in the presence of ambiguity and real losses.
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