Prospect Theory and the Newsvendor Problem

It is clarified that Prospect Theory, a prevalent framework for decision making under uncertainty, cannot explain the consistent empirical findings of the newsvendor problem.

Abstract

The newsvendor problem is a fundamental decision problem in operations management. Various independent experimental studies in laboratory settings have shown similar deviations from the theoretical optimal order quantity. We clarify that Prospect Theory, a prevalent framework for decision making under uncertainty, cannot explain the consistent empirical findings. This paper was accepted by Yossi Aviv, operations management.