Abstract
Laboratory experiments with and without real money repeatedly reveal that even if all subjects observe the same pair of cumulative distributions F and G, they act as if they were other cumulative probability functions F* and G* different for different investors. Namely, the subjects assign (subjective) weights to the various probabilities. In their breakthrough article Kahneman and Tversky [1979] suggest that in making decisions under uncertainty, the subjects apply a monotonic transformation π(p) where p are the probabilities, and investors make decisions by comparing π(p) corresponding to the two distributions under consideration rather than by comparing the true probabilities, p, themselves.
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Levy, H., Wiener, Z. Stochastic Dominance and Prospect Dominance with Subjective Weighting Functions. Journal of Risk and Uncertainty 16, 147–163 (1998). https://doi.org/10.1023/A:1007730226688
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DOI: https://doi.org/10.1023/A:1007730226688