The focus of this contribution is on the transformation of objective probability, which in Prospect Theory is commonly referred as probability weighting. Empirical evidence suggests a typical inverse-S shaped function: decision makers tend to overweight small probabilities, and underweight medium and high probabilities; moreover, the probability weighting function is initially concave and then convex. We apply different parametric weighting functions proposed in the literature to the evaluation of derivative contracts and to insurance premium principles.

A Note on the Shape of the Probability Weighting Function

Nardon, Martina
;
Pianca, Paolo
2018-01-01

Abstract

The focus of this contribution is on the transformation of objective probability, which in Prospect Theory is commonly referred as probability weighting. Empirical evidence suggests a typical inverse-S shaped function: decision makers tend to overweight small probabilities, and underweight medium and high probabilities; moreover, the probability weighting function is initially concave and then convex. We apply different parametric weighting functions proposed in the literature to the evaluation of derivative contracts and to insurance premium principles.
2018
Mathematical and Statistical Methods for Actuarial Sciences and Finance
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Utilizza questo identificativo per citare o creare un link a questo documento: https://hdl.handle.net/10278/3702992
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