Research Seminar Archive
Dr Sanjit Dhami (Leicester): Composite Prospect Theory: A proposal to combine prospect theory with cumulative prospect theory
Abstract: Evidence suggests three important stylized facts, S1, S2a, S2b.
Low probabilities are overweighted, high probabilities are underweighted (S1). Some people ignore events of extremely low probability and treat events of extremely high probability as certain (S2a). Others focus greatly on the size of outcomes, even for extremely low/high probabilities (S2b). We propose composite-cumulative-prospect-theory (CCP) that accounts jointly for S1, S2a, S2b. We discuss several applications, including insurance behavior, the class of Becker-paradoxes, the Allais-paradox and the St. Petersburg-paradox. CCP explains everything that expected utility, rank dependent utility, prospect theory and cumulative prospect theory do; the converse is false.
An Economics and Finance Research Seminar.