Stochastic Dominance and Cumulative 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 (2002) 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.

• 저널Management Science · 52(9) · 1409–1423
• 토픽Decision-Making and Behavioral Economics · General Decision Sciences
• DOI10.1287/mnsc.1060.0537
• 저자Manel Baucells, Franz H. Heukamp