An Experimental Comparison of Risky and Diskless Choice – Limitations of Prospect Theory and Expected Utility Theory
37 Pages Posted: 2 Mar 2016
Date Written: February 29, 2016
Prospect theory, widely used descriptively for decisions under both risk and certainty, presumes concave utility over “gains” and convex utility over “losses”; a pattern widely seen in lottery tasks. Although such gain-loss asymmetry is also widely used to model riskless choices, limited empirical evidence supports this use. In incentive-compatible experiments we find that in riskless choice gain-loss asymmetries are not observed as predicted by prospect theory even while in the same participants gain-loss asymmetries are observed under risk. Our results imply that utility functions under conditions of certainty can be more closely approximated using neoclassical rather than prospect theoretic preferences.
Keywords: indifference curve; riskless choice; reflection effect; reference point; losses
JEL Classification: D81
Suggested Citation: Suggested Citation