Are People Really Risk Seeking for Losses?
4 Pages Posted: 15 Dec 2009
Date Written: December 14, 2009
This short paper demonstrates that the claim of Cumulative Prospect Theory (CPT) that people are risk seeking for loss prospects appears to be merely a result of using a specific form of the probability weighting function to estimate the power factor of the value function. Using experimental data and the form of the probability weighting function presented by CPT gives a power factor for losses of less than 1. This would mean that people are risk seeking for loss prospects. However, once more flexible, two-parameter forms are used, the power factor takes on values between 1.04 and 1.10. This, however, makes the value function convex, which indicates risk aversion. It follows that people are generally risk averse both for gains and for losses. This contradicts one of the main theses of Prospect Theory.
Keywords: Prospect Theory, Value Function, Probability Weighting Function, Risk Attitude
JEL Classification: C91, D03, D81, D87
Suggested Citation: Suggested Citation