People are sometimes risk-averse in gains but risk-loving in losses. Such behavior and other anomalies underlying prospect theory arise from a model of local status maximization in which consumers compare their wealth with other consumers of similar wealth. This social explanation shares key features with the psychological explanation offered by Kahneman and Tversky. JEL Classification: D81, D11

We study equilibrium trading strategies and market quality in an economy in which speculators display preferences consistent with Prospect Theory (Kahneman and Tversky, [39]; Tversky and Kahneman, [63]), i.e., loss aversion and mild risk seeking in losses. Loss aversion (risk seeking in losses) induces speculators to trade less (more), and less cautiously (more aggressively), with their private...

Prospect theory is currently the main descriptive theory of decision under uncertainty. It generalizes expected utility by introducing nonlinear decision weighting and loss aversion. A difficulty in the study of multiattribute utility under prospect theory is to determine when an attribute yields a gain or a loss. One possibility, which has been adopted in the existing theoretical literature on...

A behavioral representative investor who evaluates a single risky asset based on cumulative prospect theory will often induce high kurtosis, negative skewness, and persistent autocorrelation into the distribution of market returns even if the asset payoffs are merely a sequence of independent coin tosses. These findings continue to hold even when the investor is simply loss averse.

In previous models of (cumulative) prospect theory reference-dependence of preferences is imposed beforehand and the location of the reference point is exogenously determined. This note provides a foundation of prospect theory, where reference-dependence is derived from preference conditions and a unique reference point arises endogenously.