In this paper we compute the asset allocation obtained with different parametrizations of Cumulative Prospect Theory; in this settings, Prospect Theory and Expected Utility are seen as special cases. We first look for the optimal portfolio in an artificial financial market, where the asset returns are generated such that each return is endowed with some desired statistical properties (i.e. the ...

Under expected utility theory, unconditional expected utility can be decomposed into a weighted sum of conditional expected utilities where the weights are marginal probabilities. We derive necessary and sufficient conditions for a similar decomposition in the framework of Cumulative Prospect Theory (CPT). The conditions also ensure that a decision maker’s conditional preferences (given some ev...

We present a novel variant of decision making based on the mathematical theory of separable Hilbert spaces. This mathematical structure captures the effect of superposition of composite prospects, including many incorporated intentions, which allows us to describe a variety of interesting fallacies and anomalies that have been reported to particularize the decision making of real human beings. ...

This study examines Kahneman and Tversky's prospect theory in the commercial banking industry. Prospect theory predicts increased risk-taking behavior in the presence of below-target outcomes. Fishburn redefined risk (commonly measured as dispersion about the mean outcome) as the integral of a function that is based on distance below target outcome. This study uses rates of return and the prima...

We demonstrate that in simple 2 × 2 games (cumulative) prospect theory preferences can be evolutionarily stable, i.e. a population of players with prospect theory preferences can not be invaded by more rational players. This holds also if probability weighting is applied to the probabilities of mixed strategies. We also show that in a typical game with infinitely many strategies, the “war of at...

This paper characterizes the conditions for risk aversion in cumulative prospect theory where risk aversion is defined in the strong sense of Rothschild and Stiglitz (1970). Under weaker assumptions than differentiability we show that risk aversion implies convex weighting functions for gains and for losses but not necessarily a concave utility function. Also, we investigate the exact relations...

This paper proposes an optimal selection method to address the real-world problem of environmentally friendly supplier selection, based on prospect theory. This study adopted the manufacturer’s point of view, and considered the manufacturer’s psychological and behavioral factors in the process of choosing suppliers. The first step was to build supplier-selection indexes for manufacturers. Then,...

We derive the optimal portfolio choice for an investor who behaves according to Cumulative Prospect Theory. The study is done in a oneperiod economy with one risk-free asset and one risky asset, and the reference point corresponds to the terminal wealth arising when the entire initial wealth is invested into the risk-free asset. When it exists, the optimal holding is a function of a generalized...

Third generation prospect theory (Schmidt et al. J Risk Uncertain 36:203– 223, 2008) is a theory of choices and of judgments of highest buying and lowest selling prices of risky prospects, i.e., of willingness to pay (WTP) and willingness to accept (WTA). The gap betweenWTP andWTA is sometimes called the “endowment effect” and was previously called the “point of view” effect. Third generation p...