Foundations of the Rank-Dependent Probability Weighting Function

20 Pages Posted: 28 Oct 2019

See all articles by Matthew D. Rablen

Matthew D. Rablen

University of Sheffield - Department of Economics

Abstract

The psychological basis for rank-dependent probability weighting, and for an inverse-S probability weighting function (PWF) in particular, has often been questioned. I examine the existence and shape of the PWF in a model allowing for optimism/pessimism over probability distributions and for loss averse/gain loving stochastic reference dependence. I give commonly observed shapes of PWF a psychological interpretation. In particular, I establish a deep connection between two of the most established phenomena in decisionmaking: loss aversion and the inverse-S PWF: the former is a pre- condition for the latter.

Keywords: probability weighting, rank dependent expected utility, loss aversion, reference dependence, optimism, pessimism

JEL Classification: D81, D01

Suggested Citation

Rablen, Matthew D., Foundations of the Rank-Dependent Probability Weighting Function. IZA Discussion Paper No. 12701. Available at SSRN: https://ssrn.com/abstract=3475807

Matthew D. Rablen (Contact Author)

University of Sheffield - Department of Economics ( email )

9 Mappin Street
Sheffield, S1 4DT
United Kingdom

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