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Cumulative prospect theory challenges traditional expected utility theory

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Abstract:

The Cumulative Prospect Theory (CPT) uses piecewise value functions instead of consumer utility and provides alternative assumptions for investment behaviour approximated by power value function. In this study, our aim to find a generalized value function that will make the value function introduced by Kahneman–Tversky (1992) a special case. This functional form of the value function determine the appropriate parameter of the values function. We believe that if one can approximate the original CPT value function by other types of functions, the optimization problem and the many other implications can be compared to choose the best model depending on the focus of the problems. This, eventually, could result in improving the theory in both theoretical and empirical points of views.

Keywords: D01; D03; G10; G11; utility theory; prospect theory; expected utility; portfolio optimization

Document Type: Research Article

DOI: http://dx.doi.org/10.1080/09603107.2011.583393

Affiliations: 1: Department of Economics,M. Kemal University-Hatay, 2: Faculty of Economics, University of Zurich, Institute of Applied Mathematics, Middle East Technical University, Ankara 06531, Turkey

Publication date: November 1, 2011

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