A revealed reference point for prospect theory

Werner, Katarzyna; Zank, Horst

doi:10.1007/s00199-017-1096-2

Cited by 37 publications

(20 citation statements)

References 85 publications

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“…Babcock (2015), Bougherara and Piet (2018) and Sproul and Michaud (2018) all make the Cumulative PT (CPT) assumption set (Tversky & Kahneman, 1992), which extends PT by changing weights on the cumulation of objective probabilities rather than on state-specific probabilities. However, these works struggled with identifying the appropriate point of reference to use when computing gains and losses and they are not alone in this regard (Werner & Zank, 2019). The works choose a variety of reference outcomes, including expected profit absent insurance.…”

Section: Introductionmentioning

confidence: 99%

Depressed demand for crop insurance contracts, and a rationale based on third generation Prospect Theory

Feng

Hennessy

2019

Agricultural Economics

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When actuarially fair insurance for a major risk is available then standard economic theory posits that those subject to the risk should insure. In agriculture, it is common for producers to decline contract offers where presubsidy premiums just cover average losses and subsidies are substantial. This paper seeks to shed light on why demand is curtailed. In a mail survey of U.S. corn and soybean producers we solicited Willingness to Pay (WTP) for actuarially fair insurance at different coverage levels. We find demand to be so low that median WTP is no larger than fair premium when adjusted down by current subsidy rates, which pay for one half or more of most premium charges. WTP as a share of the fair rate is especially low when risk of loss is high. There is limited evidence that respondents appreciate the convex relationship between coverage level and expected indemnity payoff. Third generation Prospect Theory is shown to be consistent with observed findings. In particular, a strong distaste for paying premium can be rationalized by loss aversion. Furthermore, when high revenue outcomes are more likely than not, that is, negative skewness, then higher loss aversion, greater decision weight distortions and greater risk aversion will decrease WTP.

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Section: Introductionmentioning

confidence: 99%

Depressed demand for crop insurance contracts, and a rationale based on third generation Prospect Theory

Feng

Hennessy

2019

Agricultural Economics

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“…We adopt the probability midweight tool of van de Kuilen and Wakker (2011). This tool has recently been adopted by Werner and Zank (2019) to provide preference foundations for PT in a static framework without prior knowledge of the location for the reference point. Werner and Zank indicate that the probability midweight method is suitable for empirically detecting reference point effects beyond it being a non-parametric way of eliciting probability weighting effects and its appeal for comparative analyses.…”

Section: Insensitivity and Delaymentioning

confidence: 99%

Delayed probabilistic risk attitude: a parametric approach

2019

Self Cite

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Experimental studies suggest that individuals exhibit more risk aversion in choices among prospects when the payment and resolution of uncertainty are immediate relative to when it is delayed. This leads to preference reversals that cannot be attributed to discounting. When data suggest that utility is time-independent, probability weighting functions, such as those used to model prospect theory preferences, can accommodate such reversals. We propose a simple descriptive model with a two-parameter probability weighting function where one of these parameters depends on the time at which a prospect is resolved. The time-dependent parameter is responsible for the curvature of the probability weighting function and is regarded as an index of (in)sensitivity towards changes in probabilities. We provide conditions that characterize increased sensitivity towards more distant probabilities; this can account for the observed relatively less risk aversion towards delayed prospects. In our framework, the discount function is unrestricted, such that the model is compatible with empirical findings of non-constant discounting. In a simple application to bargaining we illustrate when it is advantageous for an individual to advance or delay the bargaining resolution time if an opponent displays increased sensitivity towards probability changes with delay.

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“…Giraud (2004a), Masatlioglu and Ok (2005), Sugden (2003), Sagi (2006), Rubinstein and Salant (2007), Apesteguia andBallester (2009), Ortoleva (2010), Riella and Teper (2014) and Masatlioglu and Ok (2013) provide models of reference dependence, where the reference point is exogenously given. Along with Kőzsegi and Rabin (2006) and Kőszegi and Rabin (2007), other papers that tackle the problem of endogenous reference point determination are Giraud (2004b), Sarver (2011), Ok et al (2014, and Werner and Zank (2017). The approach in Ok et al (2014) investigates reference point determination problem under a very general framework, where they do not need an equilibrium condition to characterize reference dependence.…”

Section: Related Literaturementioning

confidence: 99%

Asymmetric gain–loss reference dependence and attitudes toward uncertainty

Lleras¹,

Piermont

Svoboda

2018

Econ Theory

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This paper characterizes a model of reference dependence, where a state-contingent contract (act) is evaluated by its expected value and its expected gain-loss utility. The expected utility of an act serves as the reference point; hence, gains (resp., losses) occur when the act provides an outcome that is better (worse) than expected. The utility representation is characterized by a belief regarding the state space and a degree of reference dependence; both are uniquely identified from behavior. We establish a link between this type of reference dependence and attitudes toward uncertainty. We show that loss aversion and reference dependence are equivalent to max-min and concave expected utility.

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A revealed reference point for prospect theory

Cited by 37 publications

References 85 publications

Depressed demand for crop insurance contracts, and a rationale based on third generation Prospect Theory

Depressed demand for crop insurance contracts, and a rationale based on third generation Prospect Theory

Delayed probabilistic risk attitude: a parametric approach

Asymmetric gain–loss reference dependence and attitudes toward uncertainty

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