Article ID: | iaor20081186 |
Country: | United States |
Volume: | 52 |
Issue: | 9 |
Start Page Number: | 1409 |
End Page Number: | 1423 |
Publication Date: | Sep 2006 |
Journal: | Management Science |
Authors: | Baucells Manel, Heukamp Franz H. |
Keywords: | prospect theory |
We generalize and extend the second-order stochastic dominance condition for expected utility to cumulative prospect theory. The new definitions include preferences represented by S-shaped value functions, inverse S-shaped probability weighting functions, and loss aversion. The stochastic dominance conditions supply a framework to test different features of cumulative prospect theory. In the experimental part of the paper, we offer a test of several joint hypotheses on the value function and the probability weighting function. Assuming empirically relevant weighting functions, we can reject the inverse S-shaped value function recently advocated by Levy and Levy in favor of the S-shaped form. In addition, we find generally supporting evidence for loss aversion. Violations of loss aversion can be explained by subjects using the overall probability of winning as a heuristic.