LAUSR.org creates dashboard-style pages of related content for over 1.5 million academic articles. Sign Up to like articles & get recommendations!

The empirical adequacy of cumulative prospect theory and its implications for normative assessment

Photo from wikipedia

Much behavioral welfare economics assumes that expected utility theory (EUT) does not accurately describe most human choice under risk. A substantial literature instead evaluates welfare consequences by taking cumulative prospect… Click to show full abstract

Much behavioral welfare economics assumes that expected utility theory (EUT) does not accurately describe most human choice under risk. A substantial literature instead evaluates welfare consequences by taking cumulative prospect theory (CPT) as the natural default alternative, at least where description is concerned. We present evidence, based on a review of previous literature and new experimental data, that the most empirically adequate hypothesis about human choice under risk is that it is heterogeneous, and that where EUT does not apply, more choice is characterized by rank-dependent utility models than by CPT. Most of the apparently loss-averse choice behavior results from probability weighting rather than from direct disutility experienced when an outcome is framed as a loss against an idiosyncratic reference point. We then consider implications of this finding for methodological debates about how to model welfare effects of policies, and argue that abandonment of a dogmatic belief in CPT as the correct theory of risk human choice exposes a conceptual error that is widespread in behavioral welfare economics. We provide concluding reflections on second-order, philosophical issues around the grounding of normative commitments in policy-focused economics.

Keywords: theory; cumulative prospect; prospect theory; choice; economics

Journal Title: Journal of Economic Methodology
Year Published: 2017

Link to full text (if available)


Share on Social Media:                               Sign Up to like & get
recommendations!

Related content

More Information              News              Social Media              Video              Recommended



                Click one of the above tabs to view related content.