Measuring the Time Stability of Prospect Theory Preferences

25 Pages Posted: 7 Oct 2009 Last revised: 24 Jan 2013

See all articles by Stefan Zeisberger

Stefan Zeisberger

Radboud University, Institute for Management Research; University of Zurich, Department of Banking and Finance

Dennis Vrecko

University of Muenster - Finance Center Muenster

Thomas Langer

University of Muenster - Finance Center

Date Written: September 22, 2010

Abstract

Prospect Theory is widely regarded as the most promising descriptive model for decision making under uncertainty. Various tests have corroborated the validity of the characteristic fourfold pattern of risk attitudes implied by the combination of probability weighting and value transformation. But is it also safe to assume stable Prospect Theory preferences at the individual level? This is not only an empirical but also a conceptual question. Measuring the stability of preferences in a multi-parameter decision model such as Prospect Theory is far more complex than evaluating single-parameter models such as Expected Utility Theory under the assump-tion of constant relative risk aversion. There exist considerable interdependencies among parameters such that allegedly diverging parameter combinations could in fact produce very similar preference structures. In this paper, we provide a theoretic framework for measuring the (temporal) stability of Prospect Theory parameters. To illustrate our methodology, we further apply our approach to 86 subjects for whom we elicit Prospect Theory parameters twice, with a time lag of one month. While documenting remarkable stability of parameter estimates at the aggregate level, we find that a third of the subjects show significant instability across sessions.

Keywords: Prospect Theory, time stability, risk preferences, experimental economics

JEL Classification: D81, C91

Suggested Citation

Zeisberger, Stefan and Vrecko, Dennis and Langer, Thomas, Measuring the Time Stability of Prospect Theory Preferences (September 22, 2010). Theory and Decision, Vol. 72, 359-386, 2012, Available at SSRN: https://ssrn.com/abstract=1481744

Stefan Zeisberger (Contact Author)

Radboud University, Institute for Management Research ( email )

Nijmegen
Netherlands

University of Zurich, Department of Banking and Finance ( email )

Z├╝rich
Switzerland

Dennis Vrecko

University of Muenster - Finance Center Muenster ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany
+49 251 703 691 - 11 (Phone)
+49 251 703 691 - 20 (Fax)

HOME PAGE: http://www.wiwi.uni-muenster.de/fcm/finance/organisation/details.php?weobjectID=215

Thomas Langer

University of Muenster - Finance Center ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany
+49 251 83 22033 (Phone)

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