What is Loss Aversion?

A behavioral definition of loss aversion is proposed and its implications for original and cumulative prospect theory are analyzed. Original prospect theory is in agreement with the new loss aversion condition, and there utility is capturing all effects of loss aversion. In cumulative prospect theory loss aversion is captured by both the weighting functions and the utility function. Further, some restrictions apply for the weighting functions involved in the latter model.We are indebted to Michèle Cohen and Peter Wakker for helpful comments. The suggestions of an anonymous referee have improved the presentation of the paper.     

Separating curvature and elevation: A parametric probability weighting function

This paper presents a preference foundation for a two-parameter family of probability weighting functions. We provide a theoretical link between the well-established notions of probabilistic risk attitudes (i.e., optimism and pessimism) used in economics and the important independent measures for individual behavior used in the psychology literature (i.e., curvature and elevation). One of the parameters in our model measures curvature and represents the diminishing effect of optimism and pessimism when moving away from extreme probabilities 0 and 1. The other parameter measures elevation and represents the relative strength of optimism vs. pessimism. Our empirical analysis indicates that the new weighting function fits elicited probability weights well, and that it can explain differences in the treatment of probabilities for gains compared to that for probabilities of losses.     

On intertemporal poverty measures: the role of affluence and want

This paper proposes classes of intertemporal poverty measures which take into account both the debilitating impact of prolonged spells in poverty and the mitigating effect of periods of affluence on subsequent poverty. The weight assigned to the level of poverty in each time period depends on the length of the preceding spell of poverty or of non-poverty. The proposed classes of intertemporal poverty measures are quite general and allow for a range of possible judgements as to the overall impact on a poor period of preceding spells of poverty or affluence. We discuss the properties of the proposed classes of measures and axiomatically characterize these measures.     

Delayed probabilistic risk attitude: a parametric approach

Theory and Decision - Experimental studies suggest that individuals exhibit more risk aversion in choices among prospects when the payment and resolution of uncertainty are immediate relative to...     

Risk behavior for gain,loss, and mixed prospects

This study extends experimental tests of (cumulative) prospect theory (PT) over prospects with more than three outcomes and tests second-order stochastic dominance principles (Levy and Levy, Management Science 48:1334–1349, 2002; Baucells and Heukamp, Management Science 52:1409–1423, 2006). It considers choice behavior of people facing prospects of three different types: gain prospects (losing is not possible), loss prospects (gaining is not possible), and mixed prospects (both gaining and losing are possible). The data supports the distinction of risk behavior into these three categories of prospects, Further, probability weighting and diminishing sensitivity of utility as predicted by PT are observed. Loss aversion is, however, less pronounced, except for choices where one prospect is degenerate. The data suggests that the probability of losing may be relevant for loss aversion.     

A genuine foundation for prospect theory

In most models of (cumulative) prospect theory, reference dependence of preferences is imposed beforehand and the location of the reference point is determined exogenously. This paper presents principles that provide critical tests and foundations for prospect theory preferences without assuming reference-dependent preferences a priori. Instead, reference dependence is derived from behavior and the reference point arises endogenously.     

Social welfare functions with a reference income

A foundation of social welfare functions is considered with a given reference income (or utility): relative and absolute invariance of the underlying welfare ordering are defined to hold for societies with either all members having incomes below the reference income or all members having incomes above the reference income. These conditions, alongside standard properties of a social preference relation, provide reference income dependent extensions of traditional classes of welfare functions. Dalton’s principle of positive transfers is incorporated, under which relative invariance leads to a class of piecewise (rank-)linear welfare functions, including the class of generalized Gini social welfare functions as a special case. To ensure quasi-concavity a new preference condition is proposed, which has the interpretation of aversion to income dropping below the reference income.     

Introduction to the Special Issue in Honor of Peter Wakker

Theory and Decision -     

Chance theory: A separation of riskless and risky utility

Journal of Risk and Uncertainty - In a temporal context, sure outcomes may yield higher utility than risky ones as they are available for the execution of plans before the resolution of...     

On probabilities and loss aversion

This paper reviews the most common approaches that have been adopted to analyze and describe loss aversion under prospect theory. Subsequently, it is argued that loss aversion is a property of observable choice behavior and two new definitions of loss averse behavior are advocated. Under prospect theory, the new properties hold if the commonly used utility based measures of loss aversion are corrected by a probability based measure of loss aversion and their product exceeds 1. It is shown that prominent parametric families of weighting functions, while successful in accommodating empirical findings on probabilistic risk attitudes, may not fit well with the theoretical implications of the new loss averse behavior conditions.