TY - JOUR
T1 - Estimating prospect theory's decision weights with stochastic dominance
T2 - The small probability case
AU - Levy, Haim
AU - Orkan, Michal
N1 - Publisher Copyright:
© 2012 World Scientific Publishing Company.
PY - 2012/12/1
Y1 - 2012/12/1
N2 - When one prospect is certain and the other uncertain, Cumulative Prospect Theory employs the certainty equivalent methodology to estimate Decision Weights (DW). However, DW may be different with two uncertain prospects. In this study, we neutralize the "certainty effect"and propose Stochastic Dominance (SD) to estimate DW for the first time with small probabilities, which is the raison d'être of the employment of DW. Using SD we provide ranges, rather than point estimates, of DW parameters that are consistent with all possible S-shape value functions. Comparing CE and SD implied DW, we find that DW are situation dependent: DW derived with one certain prospect are much different than those derived with two uncertain prospects.
AB - When one prospect is certain and the other uncertain, Cumulative Prospect Theory employs the certainty equivalent methodology to estimate Decision Weights (DW). However, DW may be different with two uncertain prospects. In this study, we neutralize the "certainty effect"and propose Stochastic Dominance (SD) to estimate DW for the first time with small probabilities, which is the raison d'être of the employment of DW. Using SD we provide ranges, rather than point estimates, of DW parameters that are consistent with all possible S-shape value functions. Comparing CE and SD implied DW, we find that DW are situation dependent: DW derived with one certain prospect are much different than those derived with two uncertain prospects.
KW - certainty effect
KW - Cumulative prospect theory
KW - decision weights
KW - expected utility
KW - S-shape value function
KW - stochastic dominance
UR - http://www.scopus.com/inward/record.url?scp=85122038747&partnerID=8YFLogxK
U2 - 10.1142/S2010495212500066
DO - 10.1142/S2010495212500066
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AN - SCOPUS:85122038747
SN - 2010-4952
VL - 7
JO - Annals of Financial Economics
JF - Annals of Financial Economics
IS - 2
M1 - 1250006
ER -