A simple preference foundation of cumulative prospect theory with power utility

Peter P. Wakker, Horst Zank

Research output: Contribution to journalArticlepeer-review

Abstract

Most empirical studies of rank-dependent utility and cumulative prospect theory have assumed power utility functions, both for gains and for losses. As it turns out, a remarkably simple preference foundation is possible for such models: Tail independence (a weakening of comonotonic independence which underlies all rank-dependent models) together with constant proportional risk aversion suffice, in the presence of common assumptions (weak ordering, continuity, and first stochastic dominance), to imply these models. Thus, sign dependence, the different treatment of gains and losses, and the separation of decision weights and utility are obtained free of charge. © 2002 Elsevier Science B.V. All rights reserved.
Original languageEnglish
Pages (from-to)1253-1271
Number of pages18
JournalEuropean Economic Review
Volume46
Issue number7
DOIs
Publication statusPublished - 2002

Keywords

  • Cumulative prospect theory
  • Proportional risk aversion
  • Rank-dependent utility

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