We add some elements of prospect theory to an analytically tractable version of Lucas’s “islands†model and show that the inclusion of reference dependence, declining sensitivity and loss aversion into the agents’ utility function leads to three main results. First, the...

We add some elements of prospect theory to an analytically tractable version of Lucas's “islands” model and show that the inclusion of reference dependence, declining sensitivity and loss aversion into the agents’ utility function leads to four main results. First, the presence of...