Randomized strategies and prospect theory in a dynamic context

When prospect theory (PT) is applied in a dynamic context, the probability weighting component brings new challenges. We study PT agents facing optimal timing decisions and consider the impact of allowing them to follow randomized strategies. In a continuous-time model of gambling and optimal stoppi...

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Bibliographic Details
Published in:Journal of economic theory 2017-03, Vol.168, p.287-300
Main Authors: Henderson, Vicky, Hobson, David, Tse, Alex S.L.
Format: Article
Language:English
Subjects:
Behavioral economics
Probability weighting
Prospect theory
Randomized strategies
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Summary:When prospect theory (PT) is applied in a dynamic context, the probability weighting component brings new challenges. We study PT agents facing optimal timing decisions and consider the impact of allowing them to follow randomized strategies. In a continuous-time model of gambling and optimal stopping, Ebert and Strack (2015) show that a naive PT investor with access only to pure strategies never stops. We show that allowing randomization can significantly alter the predictions of their model, and can result in voluntary cessation of gambling.
ISSN:0022-0531
1095-7235
DOI:10.1016/j.jet.2017.01.003