Prospect Theory: For Risk and Ambiguity provides the first comprehensive and accessible textbook treatment of the way decisions are made both when we have the statistical probabilities associated with uncertain future events (risk) and when we lack them (ambiguity). The book presents models, primarily prospect theory, that are both tractable and psychologically realistic. A method of presentation is chosen that makes the empirical meaning of each theoretical model completely transparent. Prospect theory has many applications in a wide variety of disciplines. The material in the book has been carefully organized to allow readers to select pathways through the book relevant to their own interests. With numerous exercises and worked examples, the book is ideally suited to the needs of students taking courses in decision theory in economics, mathematics, finance, psychology, management science, health, computer science, Bayesian statistics, and engineering.
Preface
Introduction 1
Prospect theory 2
Behavioral foundations 2
Homemorphic versus paramorphic modeling 3
Intended audience 3
Attractive features of decision theory 4
Structure 4
Preview 5
Our five-step presentation of decision models 7
Part I Expected utility
1 The general model of decision under uncertainty and no-arbitrage (expected utility with known utilities and unknown probabilities) 11
1.1 Basic definitions 11
1.2 Basic properties of preferences 15
1.3 Expected value 17
1.4 Datas fitting for expected value 19
1.5 The bookmaking argument of de Finetti, or the no-arbitrage condition from finance 22
1.6 A behavioral foundation of subjective probabilites and expected value using no-arbitrage and no-book 2
1.7 Discussion of structural Assumption 1.1.1 (Decision under uncertainty) 32
1.8 The general nature and usefulness of behavioral foundations 34
1.9 Appendix: Natural, technical, and intuitive preference conditions, and the problematic completeness condition 37
1.10 Appendix: The relation of Theorem 1.6.1 to the literature 39
1.11 Appendix: Proof of Theorem 1.6.1 and Observation 1.6.1 41
2 Expected utility with known probabilities - "risk" - and unknown utilities 44
2.1 Decision under risk as a special case of decision under uncertainty 44
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