Prospect Theory or Skill Signaling?

17 Pages Posted: 28 May 2002 Last revised: 22 Jun 2020

See all articles by Rick Harbaugh

Rick Harbaugh

Indiana University - Kelley School of Business - Department of Business Economics & Public Policy; Indiana University - Department of Economics

Date Written: June 15, 2020

Abstract

Formalizing early social psychology models, we show that a rational desire to avoid looking unskilled generates prospect theory's anomalies of loss aversion, probability weighting, and framing. Loss aversion arises because losing any gamble, even a friendly bet with little or no money at stake, reflects poorly on the decision maker's skill. Probability weighting emerges because winning a gamble with a low probability of success is a strong signal of skill, while losing a gamble with a high probability of success is a strong signal of incompetence. Framing can affect behavior by selecting among multiple equilibria.

Keywords: prospect theory, regret theory, probability weighting, loss aversion, framing

JEL Classification: D81, D82, C92, G11

Suggested Citation

Harbaugh, Rick, Prospect Theory or Skill Signaling? (June 15, 2020). Available at SSRN: https://ssrn.com/abstract=311409 or http://dx.doi.org/10.2139/ssrn.311409

Rick Harbaugh (Contact Author)

Indiana University - Kelley School of Business - Department of Business Economics & Public Policy ( email )

Bloomington, IN 47405
United States
812-855-2777 (Phone)
812-855-3354 (Fax)

HOME PAGE: http://www.bus.indiana.edu/riharbau/

Indiana University - Department of Economics ( email )

Wylie Hall
Bloomington, IN 47405-6620
United States

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