Non-Monotonicity of the Tversky-Kahneman Probability-Weighting Function: A Cautionary Note

6 Pages Posted: 13 May 2008

See all articles by Jonathan E. Ingersoll

Jonathan E. Ingersoll

Yale School of Management - International Center for Finance

Multiple version iconThere are 2 versions of this paper

Abstract

Cumulative Prospect Theory has gained a great deal of support as an alternative to Expected Utility Theory as it accounts for a number of anomalies in the observed behavior of economic agents. Expected Utility Theory uses a utility function and subjective or objective probabilities to compare risky prospects. Cumulative Prospect Theory alters both of these aspects. The concave utility function is replaced by a loss-averse utility function and probabilities are replaced by decision weights. The latter are determined with a weighting function applied to the cumulative probability of the outcomes. Several different probability weighting functions have been suggested. The two most popular are the original proposal of Tversky and Kahneman and the compound-invariant form proposed by Prelec. This note shows that the Tversky-Kahneman probability weighting function is not increasing for all parameter values and therefore can assign negative decision weights to some outcomes. This in turn implies that Cumulative Prospect Theory could make choices not consistent with first-order stochastic dominance.

Suggested Citation

Ingersoll, Jonathan E., Non-Monotonicity of the Tversky-Kahneman Probability-Weighting Function: A Cautionary Note. European Financial Management, Vol. 14, No. 3, pp. 385-390, June 2008, Available at SSRN: https://ssrn.com/abstract=1132535 or http://dx.doi.org/10.1111/j.1468-036X.2007.00439.x

Jonathan E. Ingersoll (Contact Author)

Yale School of Management - International Center for Finance ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-432-5924 (Phone)
203-432-6974 (Fax)

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
3
Abstract Views
654
PlumX Metrics