Foundations of the Rank-Dependent Probability Weighting Function
20 Pages Posted: 28 Oct 2019
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: Suggested Citation