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Conference of 2007
Finance Center Münster
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Cumulative prospect theory (CPT) is widely considered to be the most successful descriptive theory for decision making under risk and uncertainty. Recently, sophisticated methods have been developed to reliably elicit CPT parameters on an individual basis (e.g., Abdellaoui, Bleichrodt, and Paraschiv 2007). The aim of this paper is to analyze whether such methods are suited to be applied in real world situations, in particular, in the context of investment counseling. Specifically, we examine whether CPT parameters elicited via standardized computer tools are successful in predicting the individual’s willingness to pay (WTP) for different investment products. In a two-stage computerized experiment, we determine the CPT parameters for 200 subjects. We then elicit WTPs for various investment products and compare those to the WTPs that the subjects should have stated based on their individual CPT parameters. Surprisingly, we find hardly any predictive power of the elicited CPT parameters on the willingness to pay. We discuss several possible explanations for this finding, including domain specificity, competence effects, and decision error propagation in the elicitation of CPT parameters and WTPs. These explanations can account for at most only part of the low predictive power, which thus remains a puzzle. We therefore conclude that state-of-the-art methods of CPT parameter elicitation are not suited to be applied in a context of real world investment counseling.
Abstract
Can Prospect Theory Be Used To Predict Investor’s Willingness To Pay?
Erner, Carsten; Klos, Alexander; Langer, ThomasCumulative prospect theory (CPT) is widely considered to be the most successful descriptive theory for decision making under risk and uncertainty. Recently, sophisticated methods have been developed to reliably elicit CPT parameters on an individual basis (e.g., Abdellaoui, Bleichrodt, and Paraschiv 2007). The aim of this paper is to analyze whether such methods are suited to be applied in real world situations, in particular, in the context of investment counseling. Specifically, we examine whether CPT parameters elicited via standardized computer tools are successful in predicting the individual’s willingness to pay (WTP) for different investment products. In a two-stage computerized experiment, we determine the CPT parameters for 200 subjects. We then elicit WTPs for various investment products and compare those to the WTPs that the subjects should have stated based on their individual CPT parameters. Surprisingly, we find hardly any predictive power of the elicited CPT parameters on the willingness to pay. We discuss several possible explanations for this finding, including domain specificity, competence effects, and decision error propagation in the elicitation of CPT parameters and WTPs. These explanations can account for at most only part of the low predictive power, which thus remains a puzzle. We therefore conclude that state-of-the-art methods of CPT parameter elicitation are not suited to be applied in a context of real world investment counseling.