A Revealed Reference Point for Prospect Theory

Katarzyna M. Werner, Horst Zank

Research output: Contribution to journalArticlepeer-review

Abstract

Without an instrument to identify the reference point, prospect theory includes a degree of freedom that makes the model difficult to falsify. To address this issue, we propose a foundation for prospect theory that advances existing approaches with three innovations. First, the reference point is not known a priori; if preferences are reference-dependent, the reference point is revealed from behavior. Second, the key preference axiom is formulated as a consistency property for attitudes toward probabilities; it entails both a revealed preference test for reference-dependence and a tool suitable for empirical measurement. Third, minimal assumptions are imposed for outcomes, thereby extending the model to general settings. By incorporating these three features we deliver general foundations for prospect theory that show how reference points can be identified and how the model can be falsified.

Original languageEnglish
Pages (from-to)1-43
Number of pages43
JournalEconomic Theory
Volume67
DOIs
Publication statusPublished - 13 Jan 2018

Keywords

  • Probability midpoint
  • Prospect theory
  • Rank-dependence
  • Reference point
  • Sign-dependence

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