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Measuring the time stability of prospect theory preferences


Zeisberger, Stefan; Vrecko, Dennis; Langer, Thomas (2012). Measuring the time stability of prospect theory preferences. Theory and Decision, 72(3):359-386.

Abstract

Prospect Theory is widely regarded as the most promising descriptive model for decision mak-ing under uncertainty. Various tests have corroborated the validity of the characteristic fourfold pattern of risk attitudes implied by the combination of probability weighting and value transformation. But is it also safe to assume stable Prospect Theory preferences at the individual level? This is not only an empirical but also a con-ceptual question. Measuring the stability of preferences in a multi-parameter decision model such as Prospect Theory is far more complex than evaluating single-parameter models such as Expected Utility Theory under the assumption of constant relative risk aversion. There exist considerable interdependencies among parameters such that allegedly diverging parameter combinations could in fact produce very similar preference structures. In this paper, we provide a theoretic framework for measuring the (temporal) stability of Prospect Theory parame-ters. To illustrate our methodology, we further apply our approach to 86 subjects for whom we elicit Prospect Theory parameters twice, with a time lag of one month. While documenting remarkable stability of parameter estimates at the aggregate level, we find that a third of the subjects show significant instability across sessions.

Abstract

Prospect Theory is widely regarded as the most promising descriptive model for decision mak-ing under uncertainty. Various tests have corroborated the validity of the characteristic fourfold pattern of risk attitudes implied by the combination of probability weighting and value transformation. But is it also safe to assume stable Prospect Theory preferences at the individual level? This is not only an empirical but also a con-ceptual question. Measuring the stability of preferences in a multi-parameter decision model such as Prospect Theory is far more complex than evaluating single-parameter models such as Expected Utility Theory under the assumption of constant relative risk aversion. There exist considerable interdependencies among parameters such that allegedly diverging parameter combinations could in fact produce very similar preference structures. In this paper, we provide a theoretic framework for measuring the (temporal) stability of Prospect Theory parame-ters. To illustrate our methodology, we further apply our approach to 86 subjects for whom we elicit Prospect Theory parameters twice, with a time lag of one month. While documenting remarkable stability of parameter estimates at the aggregate level, we find that a third of the subjects show significant instability across sessions.

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Additional indexing

Item Type:Journal Article, refereed, further contribution
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:2012
Deposited On:15 Nov 2010 17:06
Last Modified:16 Feb 2018 23:05
Publisher:Springer
ISSN:0040-5833
Additional Information:The original publication is available at www.springerlink.com
OA Status:Green
Publisher DOI:https://doi.org/10.1007/s11238-010-9234-3

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