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Probability weighting and L-moments

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  • Blavatskyy, Pavlo

Abstract

Several popular generalizations of expected utility theory—cumulative prospect theory, rank-dependent utility and Yaari's dual model—allow for non-linear transformation of (de-)cumulative probabilities. This paper shows an unexpected connection between probability weighting and the statistical theory of L-moments. Specifically, cubic probability weighting results in a linear tradeoff between the expected value (the first L-moment), Gini (1912) mean difference statistic (the second L-moment, also known as L-scale) and the third L-moment (measuring skewness). Inverse S-shaped probability weighting function crossing the 45° line at a probability ≤0.5 reflects an aversion to the dispersion of outcomes and an attraction to positively skewed distributions.

Suggested Citation

  • Blavatskyy, Pavlo, 2016. "Probability weighting and L-moments," European Journal of Operational Research, Elsevier, vol. 255(1), pages 103-109.
    • Handle: RePEc:eee:ejores:v:255:y:2016:i:1:p:103-109
    DOI: 10.1016/j.ejor.2016.05.007
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