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A Satiscing Alternative to Prospect Theory

Author

Listed:
  • David B. BROWN

    (Fuqua School of Business, Duke University)

  • Enrico G. DE GIORGI

    (University of St. Gallen, Swiss Finance Institute and University of Lugano)

  • Melvyn SIM

    (NUS Business School, NUS Risk Management Institute, National University of Singapore)

Abstract

In this paper, we axiomatize a target-based model of choice that allows decision makers to be both risk averse and risk seeking, depending on the payoff's position relative to a pre- specified target. The approach can be viewed as a hybrid model, capturing in spirit two celebrated ideas: first, the satisficing concept of Simon (1955); second, the switch between risk aversion and risk seeking popularized by the prospect theory of Kahneman and Tversky (1979). Our axioms are simple and intuitive; in order to be implemented in practice, our approach requires only the specification of an aspiration level. We show that this approach is dual to a known approach using risk measures, thereby allowing us to connect to existing theory. Though our approach is intended to be normative, we also show that it resolves the classical paradoxes of Allais (1953) and Ellsberg (1961), neither of which can be explained by expected utility theory.

Suggested Citation

  • David B. BROWN & Enrico G. DE GIORGI & Melvyn SIM, 2009. "A Satiscing Alternative to Prospect Theory," Swiss Finance Institute Research Paper Series 09-19, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp0919
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    References listed on IDEAS

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    Cited by:

    1. Enrico G. De Giorgi, 2009. "Goal-Based Investing with Cumulative Prospect Theory and Satisficing Behavior," University of St. Gallen Department of Economics working paper series 2009 2009-22, Department of Economics, University of St. Gallen.

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    More about this item

    Keywords

    satisficing; aspiration levels; targets; prospect theory; reflection effect; risk measures; convex risk measures; portfolio optimization.;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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