Decision-making under uncertainty – A field study of cumulative prospect theory

• Published in: Journal of banking & finance 2009-07, Vol.33 (7), p.1221-1229
• Main Authors: Gurevich, Gregory, Kliger, Doron, Levy, Ori
• Format: Article
• Language: English
• Subjects: Cumulative prospect theory; Cumulative prospect theory Value function Probability weighting function Loss aversion; Decision making models; Decision theory; Investors; Loss; Loss aversion; Options markets; Parameter estimation; Preferences; Probability; Probability weighting function; Risk aversion; Securities prices; Studies; Uncertainty; Value function
• ISSN: 0378-4266; 1872-6372
• DOI: 10.1016/j.jbankfin.2008.12.017

The presented research tests cumulative prospect theory (CPT, [Kahneman, D., Tversky, A., 1979. Prospect theory: An analysis of decision under risk. Econometrica 47, 263–291; Tversky, A., Kahneman, D., 1981. The framing of decisions and the psychology of choice. Science 211, 453–480]) in the financial market, using US stock option data. Option prices possess information about actual investors’ preferences in such a way that an exploitation of conventional option analysis, along with theoretical relationships, makes it possible to elicit investor preferences. The option data in this study serve for estimating the two essential elements of the CPT, namely, the value function and the probability weighting function. The main part of the work focuses on the functions’ simultaneous estimation under CPT original parametric specification. The shape of the estimated functions is found to be in line with theory. Comparing to results of laboratory experiments, the estimated functions are closer to linearity and loss aversion is less pronounced.