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Measuring the time stability of Prospect Theory preferences

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Abstract

Prospect Theory (PT) is widely regarded as the most promising descriptive model for decision making 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 PT preferences at the individual level? This is not only an empirical but also a conceptual question. Measuring the stability of preferences in a multi-parameter decision model such as PT 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 PT parameters. To illustrate our methodology, we further apply our approach to 86 subjects for whom we elicit PT parameters twice, with a time lag of 1 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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Authors and Affiliations

  1. Finance Center Münster, University of Münster, Universitätsstraße 14–16, 48143, Münster, Germany

    Stefan Zeisberger, Dennis Vrecko & Thomas Langer

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  1. Stefan Zeisberger
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  2. Dennis Vrecko
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  3. Thomas Langer
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Correspondence to Stefan Zeisberger.

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Zeisberger, S., Vrecko, D. & Langer, T. Measuring the time stability of Prospect Theory preferences. Theory Decis 72, 359–386 (2012). https://doi.org/10.1007/s11238-010-9234-3

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