Prospect Theory in Choice and Pricing Tasks
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Date
2002-07-20
Authors
Harbaugh, William
Krause, Kate
Vesterlund, Lise
Journal Title
Journal ISSN
Volume Title
Publisher
University of Oregon, Dept. of Economics
Abstract
The most distinctive prediction of prospect theory is the fourfold pattern (FFP) of risk attitudes. People are said to be (1) risk-seeking over low-probability gains, (2) risk-averse over low-probability losses, (3) risk-averse over high-probability gains, and (4) risk-seeking over high-probability losses. Using simple gambles over real payoffs, we conduct a direct test of this FFP prediction. We find that when pricing gambles subjects’ risk attitudes are consistent with the FFP. However, when they choose between the gamble and its expected value, their decisions are not distinguishable from random choice and are often the exact opposite of the prediction. These results hold both between and within subjects, and are robust even when we allow the subjects to simultaneously review and change their price and choice decisions.
Description
Keywords
Probability weighting, Expected utility, Prospect theory, Cumulative prospect theory, Preference reversal, Microeconomics, Probabilities, Decision making, Game theory, Economics, Mathematical