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Journal ArticleDOI

Advances in prospect theory: cumulative representation of uncertainty

01 Oct 1992-Journal of Risk and Uncertainty (JOURNAL OF RISK AND UNCERTAINTY)-Vol. 5, Iss: 4, pp 297-323
TL;DR: Cumulative prospect theory as discussed by the authors applies to uncertain as well as to risky prospects with any number of outcomes, and it allows different weighting functions for gains and for losses, and two principles, diminishing sensitivity and loss aversion, are invoked to explain the characteristic curvature of the value function and the weighting function.
Abstract: We develop a new version of prospect theory that employs cumulative rather than separable decision weights and extends the theory in several respects. This version, called cumulative prospect theory, applies to uncertain as well as to risky prospects with any number of outcomes, and it allows different weighting functions for gains and for losses. Two principles, diminishing sensitivity and loss aversion, are invoked to explain the characteristic curvature of the value function and the weighting functions. A review of the experimental evidence and the results of a new experiment confirm a distinctive fourfold pattern of risk attitudes: risk aversion for gains and risk seeking for losses of high probability; risk seeking for gains and risk aversion for losses of low probability. Expected utility theory reigned for several decades as the dominant normative and descriptive model of decision making under uncertainty, but it has come under serious question in recent years. There is now general agreement that the theory does not provide an adequate description of individual choice: a substantial body of evidence shows that decision makers systematically violate its basic tenets. Many alternative models have been proposed in response to this empirical challenge (for reviews, see Camerer, 1989; Fishburn, 1988; Machina, 1987). Some time ago we presented a model of choice, called prospect theory, which explained the major violations of expected utility theory in choices between risky prospects with a small number of outcomes (Kahneman and Tversky, 1979; Tversky and Kahneman, 1986). The key elements of this theory are 1) a value function that is concave for gains, convex for losses, and steeper for losses than for gains,
Citations
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Journal ArticleDOI
TL;DR: In this article, the authors present a reference-dependent theory of consumer choice, which explains such effects by a deformation of indifference curves about the reference point, in which losses and disadvantages have greater impact on preferences than gains and advantages.
Abstract: Much experimental evidence indicates that choice depends on the status quo or reference level: changes of reference point often lead to reversals of preference. We present a reference-dependent theory of consumer choice, which explains such effects by a deformation of indifference curves about the reference point. The central assumption of the theory is that losses and disadvantages have greater impact on preferences than gains and advantages. Implications of loss aversion for economic behavior are considered. The standard models of decision making assume that preferences do not depend on current assets. This assumption greatly simplifies the analysis of individual choice and the prediction of trades: indifference curves are drawn without reference to current holdings, and the Coase theorem asserts that, except for transaction costs, initial entitlements do not affect final allocations. The facts of the matter are more complex. There is substantial evidence that initial entitlements do matter and that the rate of exchange between goods can be quite different depending on which is acquired and which is given up, even in the absence of transaction costs or income effects. In accord with a psychological analysis of value, reference levels play a large role in determining preferences. In the present paper we review the evidence for this proposition and offer a theory that generalizes the standard model by introducing a reference state. The present analysis of riskless choice extends our treatment of choice under uncertainty [Kahneman and Tversky, 1979, 1984; Tversky and Kahneman, 1991], in which the outcomes of risky prospects are evaluated by a value function that has three essential characteristics. Reference dependence: the carriers of value are gains and losses defined relative to a reference point. Loss aversion: the function is steeper in the negative than in the positive domain; losses loom larger than corresponding gains. Diminishing sensitivity: the marginal value of both gains and losses decreases with their

5,864 citations

Journal ArticleDOI
TL;DR: Determinants and consequences of accessibility help explain the central results of prospect theory, framing effects, the heuristic process of attribute substitution, and the characteristic biases that result from the substitution of nonextensional for extensional attributes.
Abstract: Early studies of intuitive judgment and decision making conducted with the late Amos Tversky are reviewed in the context of two related concepts: an analysis of accessibility, the ease with which thoughts come to mind; a distinction between effortless intuition and deliberate reasoning. Intuitive thoughts, like percepts, are highly accessible. Determinants and consequences of accessibility help explain the central results of prospect theory, framing effects, the heuristic process of attribute substitution, and the characteristic biases that result from the substitution of nonextensional for extensional attributes. Variations in the accessibility of rules explain the occasional corrections of intuitive judgments. The study of biases is compatible with a view of intuitive thinking and decision making as generally skilled and successful.

4,802 citations


Cites background from "Advances in prospect theory: cumula..."

  • ...…sharply kinked at the reference point and loss averse—steeper for losses than for gains by a factor of about 2–2.5 (Kahneman, Knetsch, & Thaler, 1991; Tversky & Kahneman, 1992); and (d) several studies suggest that the functions in the two domains are fairly well approximated by power functions…...

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  • ...The experimental evidence shows that most people reject a gamble with even chances to win and lose unless the possible win is at least twice the size of the possible loss (see, e.g., Tversky & Kahneman, 1992)....

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  • ...In an article titled “Risk as Feelings,” Loewenstein, Weber, Hsee, and Welch (2001) offered a closely related analysis in which emotional responses, such as the intensity of fear, govern diverse judgments (e.g., ratings of the probability of a disaster)....

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  • ...…gains by a factor of about 2–2.5 (Kahneman, Knetsch, & Thaler, 1991; Tversky & Kahneman, 1992); and (d) several studies suggest that the functions in the two domains are fairly well approximated by power functions with similar exponents, both less than unity (Swalm, 1966; Tversky & Kahneman, 1992)....

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Journal ArticleDOI
TL;DR: Kahneman as mentioned in this paper made a statement based on worked out together with Shane Federik the quirkiness of human judgment, which was later used in his speech at the Nobel Prize in economics.
Abstract: Daniel Kahneman received the Nobel Prize in economics sciences in 2002, December 8, Stockholm, Sweden. This article is the edited version of his Nobel Prize lecture. The author comes back to the problems he has studied with the late Amos Tversky and to debates conducting for several decades already. The statement is based on worked out together with Shane Federik the quirkiness of human judgment. Language: ru

4,462 citations


Cites background from "Advances in prospect theory: cumula..."

  • ...The second was concerned with prospect theory, a model of choice under risk (Kahneman and Tversky, 1979; Tversky and Kahneman, 1992) and with loss aversion in riskless choice (Kahneman et al., 1990, 1991; Tversky and Kahneman, 1991)....

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  • ...…favoring risk aversion; (2) it is convex in the domain of losses, favoring risk seeking; (3) most important, the function is sharply kinked at the reference point, and loss-averse—steeper for losses than for gains by a factor of about 2–2.5 (Kahneman et al., 1991; Tversky and Kahneman, 1992)....

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  • ...The experimental evidence shows that most people will reject a gamble with even chances to win and lose, unless the possible win is at least twice the size of the possible loss (e.g., Tversky and Kahneman, 1992)....

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  • ...A growing literature of eld research and 5 Cumulative prospect theory (Tversky and Kahneman, 1992) does not have this feature. eld experiments documents large and systematic mistakes in some of the most consequential nancial decisions that people make, including choices of investments (Brad M.…...

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  • ...This observation is entirely unremarkable—it does not seem shocking that some attributes of a stimulus are automatically perceived while others must be computed, or that the same attribute is perceived in one display of an object but must be computed in another....

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Book
01 Jul 2002
TL;DR: In this article, a review is presented of the book "Heuristics and Biases: The Psychology of Intuitive Judgment, edited by Thomas Gilovich, Dale Griffin, and Daniel Kahneman".
Abstract: A review is presented of the book “Heuristics and Biases: The Psychology of Intuitive Judgment,” edited by Thomas Gilovich, Dale Griffin, and Daniel Kahneman.

3,642 citations

Journal ArticleDOI
TL;DR: In this paper, the authors examined the implica- tions of individual differences in performance for each of the four explanations of the normative/descriptive gap, including performance errors, computational limitations, the wrong norm being applied by the experi- menter, and a different construal of the task by the subject.
Abstract: Much research in the last two decades has demon- strated that human responses deviate from the performance deemed normative according to various models of decision mak- ing and rational judgment (e.g., the basic axioms of utility theory). This gap between the normative and the descriptive can be inter- preted as indicating systematic irrationalities in human cognition. However, four alternative interpretations preserve the assumption that human behavior and cognition is largely rational. These posit that the gap is due to (1) performance errors, (2) computational limitations, (3) the wrong norm being applied by the experi- menter, and (4) a different construal of the task by the subject. In the debates about the viability of these alternative explanations, attention has been focused too narrowly on the modal response. In a series of experiments involving most of the classic tasks in the heuristics and biases literature, we have examined the implica- tions of individual differences in performance for each of the four explanations of the normative/descriptive gap. Performance er- rors are a minor factor in the gap; computational limitations un- derlie non-normative responding on several tasks, particularly those that involve some type of cognitive decontextualization. Un- expected patterns of covariance can suggest when the wrong norm is being applied to a task or when an alternative construal of the task should be considered appropriate.

3,068 citations

References
More filters
Book ChapterDOI
TL;DR: In this paper, the authors present a critique of expected utility theory as a descriptive model of decision making under risk, and develop an alternative model, called prospect theory, in which value is assigned to gains and losses rather than to final assets and in which probabilities are replaced by decision weights.
Abstract: This paper presents a critique of expected utility theory as a descriptive model of decision making under risk, and develops an alternative model, called prospect theory. Choices among risky prospects exhibit several pervasive effects that are inconsistent with the basic tenets of utility theory. In particular, people underweight outcomes that are merely probable in comparison with outcomes that are obtained with certainty. This tendency, called the certainty effect, contributes to risk aversion in choices involving sure gains and to risk seeking in choices involving sure losses. In addition, people generally discard components that are shared by all prospects under consideration. This tendency, called the isolation effect, leads to inconsistent preferences when the same choice is presented in different forms. An alternative theory of choice is developed, in which value is assigned to gains and losses rather than to final assets and in which probabilities are replaced by decision weights. The value function is normally concave for gains, commonly convex for losses, and is generally steeper for losses than for gains. Decision weights are generally lower than the corresponding probabilities, except in the range of low prob- abilities. Overweighting of low probabilities may contribute to the attractiveness of both insurance and gambling. EXPECTED UTILITY THEORY has dominated the analysis of decision making under risk. It has been generally accepted as a normative model of rational choice (24), and widely applied as a descriptive model of economic behavior, e.g. (15, 4). Thus, it is assumed that all reasonable people would wish to obey the axioms of the theory (47, 36), and that most people actually do, most of the time. The present paper describes several classes of choice problems in which preferences systematically violate the axioms of expected utility theory. In the light of these observations we argue that utility theory, as it is commonly interpreted and applied, is not an adequate descriptive model and we propose an alternative account of choice under risk. 2. CRITIQUE

35,067 citations

Book
01 Jan 1974
TL;DR: The authors described three heuristics that are employed in making judgements under uncertainty: representativeness, availability of instances or scenarios, and adjustment from an anchor, which is usually employed in numerical prediction when a relevant value is available.
Abstract: This article described three heuristics that are employed in making judgements under uncertainty: (i) representativeness, which is usually employed when people are asked to judge the probability that an object or event A belongs to class or process B; (ii) availability of instances or scenarios, which is often employed when people are asked to assess the frequency of a class or the plausibility of a particular development; and (iii) adjustment from an anchor, which is usually employed in numerical prediction when a relevant value is available. These heuristics are highly economical and usually effective, but they lead to systematic and predictable errors. A better understanding of these heuristics and of the biases to which they lead could improve judgements and decisions in situations of uncertainty.

31,082 citations

Journal ArticleDOI

27,773 citations


"Advances in prospect theory: cumula..." refers background in this paper

  • ...Some time ago we presented a model of choice, called prospect theory, which explained the major violations of expected utility theory in choices between risky prospects with a small number of outcomes (Kahneman and Tversky, 1979; Tversky and Kahneman, 1986)....

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Book
01 Jan 1954

7,545 citations

Journal ArticleDOI
Daniel Ellsberg1
TL;DR: The notion of "degrees of belief" was introduced by Knight as mentioned in this paper, who argued that people tend to behave "as though" they assigned numerical probabilities to events, or degrees of belief to the events impinging on their actions.
Abstract: Are there uncertainties that are not risks? There has always been a good deal of skepticism about the behavioral significance of Frank Knight's distinction between “measurable uncertainty” or “risk”, which may be represented by numerical probabilities, and “unmeasurable uncertainty” which cannot. Knight maintained that the latter “uncertainty” prevailed – and hence that numerical probabilities were inapplicable – in situations when the decision-maker was ignorant of the statistical frequencies of events relevant to his decision; or when a priori calculations were impossible; or when the relevant events were in some sense unique; or when an important, once-and-for-all decision was concerned. Yet the feeling has persisted that, even in these situations, people tend to behave “as though” they assigned numerical probabilities, or “degrees of belief,” to the events impinging on their actions. However, it is hard either to confirm or to deny such a proposition in the absence of precisely-defined procedures for measuring these alleged “degrees of belief.” What might it mean operationally, in terms of refutable predictions about observable phenomena, to say that someone behaves “as if” he assigned quantitative likelihoods to events: or to say that he does not? An intuitive answer may emerge if we consider an example proposed by Shackle, who takes an extreme form of the Knightian position that statistical information on frequencies within a large, repetitive class of events is strictly irrelevant to a decision whose outcome depends on a single trial.

7,005 citations


"Advances in prospect theory: cumula..." refers background in this paper

  • ...Ellsberg (1961) observed that people prefer to bet on an urn containing equal numbers of red and green balls, rather than on an urn that contains red and green balls in unknown proportions....

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