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Research output: Contribution to Journal/Magazine › Journal article › peer-review
Research output: Contribution to Journal/Magazine › Journal article › peer-review
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TY - JOUR
T1 - Loss aversion and ruinous optimal wagers in cumulative prospect theory
AU - Peel, David Alan
AU - Law, David
PY - 2017/2/22
Y1 - 2017/2/22
N2 - We demonstrate that extant parametric specifications of Cumulative Prospect Theory exhibit counterfactual implications for optimal wagers at actuarially unfair odds. In particular they imply individuals may maximizes their utility, called value function in Cumulative Prospect Theory, by wagering all or large proportions of their wealth on actuarially unfair gambles. In order to eliminate this property it is necessary that loss aversion is unbounded and increases as stake size increases. We present new parametric specifications of the value function over losses that exhibit this feature and therefore eliminate the ruinous wagering property.
AB - We demonstrate that extant parametric specifications of Cumulative Prospect Theory exhibit counterfactual implications for optimal wagers at actuarially unfair odds. In particular they imply individuals may maximizes their utility, called value function in Cumulative Prospect Theory, by wagering all or large proportions of their wealth on actuarially unfair gambles. In order to eliminate this property it is necessary that loss aversion is unbounded and increases as stake size increases. We present new parametric specifications of the value function over losses that exhibit this feature and therefore eliminate the ruinous wagering property.
KW - Cumulative prospect theory
KW - Ruinous Wagers
M3 - Journal article
VL - 37
SP - 352
EP - 360
JO - Economics Bulletin
JF - Economics Bulletin
SN - 1545-2921
IS - 1
ER -