Book contents
- Frontmatter
- Contents
- Preface
- Introduction
- Part I Expected utility
- Part II Nonexpected utility for Risk
- 5 Heuristic arguments for probabilistic sensitivity and rank dependence
- 6 Probabilistic sensitivity and rank dependence analyzed
- 7 Applications and extensions of rank dependence
- 8 Where prospect theory deviates from rank-dependent utility and expected utility: reference dependence versus asset integration
- 9 Prospect theory for decision under risk
- Part III Nonexpected utility for uncertainty
- 13 Conclusion
- Appendices
- References
- Author index
- Subject index
8 - Where prospect theory deviates from rank-dependent utility and expected utility: reference dependence versus asset integration
Published online by Cambridge University Press: 05 June 2012
- Frontmatter
- Contents
- Preface
- Introduction
- Part I Expected utility
- Part II Nonexpected utility for Risk
- 5 Heuristic arguments for probabilistic sensitivity and rank dependence
- 6 Probabilistic sensitivity and rank dependence analyzed
- 7 Applications and extensions of rank dependence
- 8 Where prospect theory deviates from rank-dependent utility and expected utility: reference dependence versus asset integration
- 9 Prospect theory for decision under risk
- Part III Nonexpected utility for uncertainty
- 13 Conclusion
- Appendices
- References
- Author index
- Subject index
Summary
Prospect theory, defined in the next chapter, adds a new component to classical theories, namely reference dependence, which is the topic of this chapter. This component is of a different nature than concepts we have defined so far. It depends on aspects of framing and entails, I think, a bigger deviation from rationality than probability weighting. It is so volatile that it is hard to model theoretically (Fatas, Neugebauer, & Tamborero 2007; Kühberger, Schulte-Mecklenbeck, & Perner 1999), and much of the handling of reference dependence takes place in the modeling stage preceding the quantitative analyses presented in this book. Hence, up till now hardly any theory has been developed for reference dependence. Nevertheless, this deviation is of major empirical importance. I think that more than half of the risk aversion empirically observed has nothing to do with utility curvature or with probability weighting. Instead, it is generated by loss aversion, the main empirical phenomenon regarding reference dependence. Hence, this chapter will discuss reference dependence, even though, unlike the remainder of this book, it will have little theory and few quantitative assessments, and there will be almost no exercises either.
Before we can discuss reference dependence, two subtle points have to be clarified that have raised much confusion in the literature. First, inconsistencies that can arise between asset integration and isolation for moderate stakes (§8.1) will not be due to inappropriateness of either principle. Rather, they result from another cause: overly strong deviations from risk neutrality for moderate stakes (§8.2).
- Type
- Chapter
- Information
- Prospect TheoryFor Risk and Ambiguity, pp. 234 - 250Publisher: Cambridge University PressPrint publication year: 2010