On the Composition of Risk Preference and Belief.

A decomposition of decision weights into a component reflecting risk attitude and a new component depending on belief is proposed, based on an observable preference condition and does not use other empirical primitives such as statements of judged probabilities.

Abstract

Prospect theory assumes nonadditive decision weights for preferences over risky gambles. Such decision weights generalize additive probabilities. This article proposes a decomposition of decision weights into a component reflecting risk attitude and a new component depending on belief. The decomposition is based on an observable preference condition and does not use other empirical primitives such as statements of judged probabilities. The preference condition is confirmed by most of the experimental findings in the literature. The implied properties of the belief component suggest that, besides the often-studied ambiguity aversion (a motivational factor reflecting a general aversion to unknown probabilities), perceptual and cognitive limitations play a role: It is harder to distinguish among various levels of likelihood, and to process them differently, when probabilities are unknown than when they are known.