Probability weighting is one of the cornerstones of decision-making theories accommodating gambling preferences. This paper examines its relevance to explaining employee stock option exercise behavior. We characterized the optimal exercise policy for a representative employee with Rank-Dependent...

This paper investigates the optimal design of incentives when agents distort probabilities. We show that the type of probability distortion displayed by the agent and its degree determine whether an incentivecompatible contract can be implemented, the strength of the incentives included in the...

This study compares the performance of Prospect Theory versus Stochastic Expected Utility Theory at fitting data on decision making under risk. Both theories incorporate well-known deviations from Expected Utility Maximization such as the Allais paradox or the fourfold pattern of risk attitudes....

We generalize the classical concept of a certainty equivalent to a model where an investor can trade on a capital market with several future trading dates. We show that if a riskless asset is traded and the investor has a CARA utility then our generalized certainty equivalent can be evaluated...

Define the riskiness of a gamble as the reciprocal of the absolute risk aversion (ARA) of an individual with constant ARA who is indifferent between taking and not taking that gamble. We characterize this index by axioms, chief among them a “duality” axiom which, roughly speaking, asserts...

If a decision maker, in a world of uncertainty à la Anscombe and Aumann (1963), can choose acts according to some objective probability distribution (by throwing dice for instance) from any given set of acts, then there is no set of acts that allows an experimenter to test more than the Axiom...

We show how optimal saving in a two-period model is affected when prudence and risk aversion of the underlying utility function change. Increasing prudence alone will induce higher savings only if, for certain combinations of the interest rate and the pure time discount rate, there is...

In the framework of expected utility theory, risk attitudes are entirely captured by the curvature of the utility function. In cumulative prospect theory (CPT) risk attitudes have an additional dimension: the weighting of probabilities. With this modification, one question arises naturally:...

Although there has been much attention in recent years on the effects of additive background risks, the same is not true for its multiplicative counterpart. We consider random wealth of the multiplicative form xy, where x and y are statistically independent random variables. We assume that y is...

Economics and management science share the tradition of ordering risk aversion by fitting the best expected utility (EU) model with a certain utility function to individual data, and then using the utility curvature for each individual as the sole index of risk attitude. (Cumulative) Prospect...