Probability Weighting Functions
18 Pages Posted: 17 Oct 2015
Date Written: October 12, 2015
Cumulative prospect theory (CPT) has been proposed as an alternative to expected utility theory to explain irregular behavior by economic agents. CPT comprises two key transformations: one of outcome values and the other of objective probabilities. Risk attitudes are derived from the shapes of these transformations as well as their interaction. The focus of this contribution is on the transformation of objective probability, which is commonly referred as probability weighting function. We review different families of weighting functions proposed in the literature and study their features.
Keywords: Cumulative prospect theory, probability weighting function
JEL Classification: C63, D81, G13
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