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Co-monotonicity of optimal investments and the design of structured financial products

Author

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  • Marc Oliver Rieger

    (University of Zurich)

Abstract

We study how the framework of classical game theory changes when the preferences of the players are described by Prospect Theory instead of Expected Utility Theory. Specifically, we study the influence of framing effect and probability weighting on the existence and specific structure of Nash equilibria in pure and mixed strategies for finite games. We demonstrate that in games representing typical interactions in societies, probability weighting of the players can lead to larger common wealth and is, under weak assumptions,evolutionary stable. This observation may provide a possible explanation for the validity of Prospect Theory as a descriptive model in human behavior.

Suggested Citation

  • Marc Oliver Rieger, 2007. "Co-monotonicity of optimal investments and the design of structured financial products," Swiss Finance Institute Research Paper Series 07-29, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp0729
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    File URL: http://ssrn.com/abstract=1020019
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    More about this item

    Keywords

    Prospect Theory; Existence of Nash Equilibria; Evolutionary stability.;
    All these keywords.

    JEL classification:

    • C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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