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On the Empirical Validity of Cumulative Prospect Theory: Experimental Evidence of Rank-Independent Probability Weighting

Bernheim, B. Douglas and Sprenger, Charles (2020) On the Empirical Validity of Cumulative Prospect Theory: Experimental Evidence of Rank-Independent Probability Weighting. . (Unpublished) https://resolver.caltech.edu/CaltechAUTHORS:20200721-142739420

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Abstract

Cumulative Prospect Theory (CPT), the leading behavioral account of decision making under uncertainty, avoids the dominance violations implicit in Prospect Theory (PT) by assuming that the probability weight applied to a given outcome depends on its ranking. We devise a simple and direct non-parametric method for measuring the change in relative probability weights resulting from a change in payoff ranks. We find no evidence that these weights are even modestly sensitive to ranks. Conventional calibrations of CPT preferences imply that the percentage change in probability weights should be an order of magnitude larger than we observe. It follows either that probability weighting is not rank-dependent, or that the weighting function is nearly linear. Non-parametric measurement of the change in relative probability weights resulting from changes in probabilities rules out the second possibility. Additional tests nevertheless indicate that the dominance patterns predicted by PT do not arise. We reconcile these findings by positing a form of complexity aversion that generalizes the well-known certainty effect.


Item Type:Report or Paper (Working Paper)
Related URLs:
URLURL TypeDescription
https://doi.org/10.2139/ssrn.3350196DOIWorking Paper
Alternate Title:Direct Tests of Cumulative Prospect theory
Additional Information:First Draft: December 1, 2014. Posted: 2 Apr 2019; Last revised: 26 May 2020. Previous versions of this paper were titled ‘Direct Tests of Cumulative Prospect Theory.’ We are grateful to Ted O’Donoghue, Colin Camerer, Nick Barberis, Kota Saito, seminar participants at Cornell, Caltech, MIT, UCLA, CIDE, Tel Aviv, UC Santa Barbara, the Stanford Institute for Theoretical Economics, and five anonymous referees for helpful and thoughtful comments. Fulya Ersoy, Vincent Leah-Martin, Seung-Keun Martinez, and Alex Kellogg all provided valuable research assistance.
Subject Keywords:Prospect Theory, Cumulative Prospect Theory, rank dependence
Classification Code:JEL: D81, D90
Record Number:CaltechAUTHORS:20200721-142739420
Persistent URL:https://resolver.caltech.edu/CaltechAUTHORS:20200721-142739420
Official Citation:Bernheim, B. Douglas and Sprenger, Charles, On the Empirical Validity of Cumulative Prospect Theory: Experimental Evidence of Rank-Independent Probability Weighting (January 17, 2020). Econometrica, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3350196 or http://dx.doi.org/10.2139/ssrn.3350196
Usage Policy:No commercial reproduction, distribution, display or performance rights in this work are provided.
ID Code:104490
Collection:CaltechAUTHORS
Deposited By: Tony Diaz
Deposited On:21 Jul 2020 21:51
Last Modified:21 Jul 2020 21:51

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