Conditioning and Updating Under Cumulative Prospect Theory

23 Pages Posted: 4 Jan 2011

See all articles by Alex Stomper

Alex Stomper

Humboldt University of Berlin - School of Business and Economics

Marie-Louise Vierø

Queen's University - Department of Economics

Date Written: November 13, 2010

Abstract

Under expected utility theory, unconditional expected utility can be decomposed into a weighted sum of conditional expected utilities where the weights are marginal probabilities. We derive necessary and sufficient conditions for a similar decomposition in the framework of Cumulative Prospect Theory (CPT). The conditions also ensure that a decision maker’s conditional preferences (given some event) remain within the CPT class. Our results are important for empirical analyses in which weighted marginal probabilities of events are used to explain a decision maker’s choices. The use of such marginal probabilities is a practical necessity in non-experimental settings.

Keywords: cumulative prospect theory, probability weighting function, conditioning, updating, dynamic consistency, consequentialism

JEL Classification: D80, D84

Suggested Citation

Stomper, Alex and Vierø, Marie-Louise, Conditioning and Updating Under Cumulative Prospect Theory (November 13, 2010). Available at SSRN: https://ssrn.com/abstract=1708662 or http://dx.doi.org/10.2139/ssrn.1708662

Alex Stomper

Humboldt University of Berlin - School of Business and Economics ( email )

Spandauer Str. 1
Berlin, D-10099
Germany

Marie-Louise Vierø (Contact Author)

Queen's University - Department of Economics ( email )

99 University Avenue
Kingston K7L 3N6, Ontario
Canada

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