The utility function under Prospect Theory
reportposted on 02.02.2010, 12:17 by Ali al-Nowaihi, Ian Bradley, Sanjit Dhami
Prospect theory is the main behavioral alternative to expected utility. Tversky and Kahnemann (1992) motivate the utility function for gains and losses under prospect theory by using the axiom of preference homogeneity. However, they do not provide the formal proof. We provide the relevant proof. Furthermore, we show that the utility function under preference homogeneity obeys an additional and important restriction that is not noted by Tversky and Kahnemann (1992). This simplifies the use of prospect theory by reducing the number of free parameters by one.