Reference dependence in cumulative prospect theory

✍ Scribed by Ulrich Schmidt

• Publisher: Elsevier Science
• Year: 2003
• Tongue: English
• Weight: 198 KB
• Volume: 47
• Category: Article
• ISSN: 0022-2496
• DOI: 10.1016/s0022-2496(02)00015-9

✦ Synopsis

A central feature of (cumulative) prospect theory is reference dependence, i.e. the value function depends on gains and losses relative to a status quo and not on final wealth positions as in expected utility theory. Until now, all theoretical work on prospect theory only considered a fixed status quo. In this case, however, reference dependence and the dependence of the value function on final wealth positions are equivalent concepts, at least if the status quo is known. In order to identify the differences between both concepts, an axiomatization of cumulative prospect theory is developed which allows for a variable status quo. In this framework a preference condition can be formulated which discriminates between reference dependence and the dependence on final wealth positions. Furthermore, this framework allows one to analyze in which way the shape of the value and weighting functions change with increasing status quo. With respect to this question several hypotheses are defined and characterized in terms of preference conditions.