What Determines the Shape of the Probability Weighting Function?

Abstract

When valuing risky prospects, people typically overweight small probabilities and underweight medium and large probabilities, but there is vast heterogeneity in individual behavior. We explore the relationship between person-specific probability weights, estimated from investment decisions in a laboratory experiment, and personal characteristics. We find considerable interaction effects with gender. While women's probability weighting is strongly and significantly susceptible to mood states, men's is not. Moreover, we show that cheerful and optimistic people weight probabilities of investment gains more favorably than do pessimistic people. People who calculate expected payoffs are less prone to probability distortions than those who do not use a lottery's expected value as a decision criterion. None of the factors studied impact subjects' valuations of monetary outcomes.

Keywords: Probability Weighting Function, Prospect Theory, Risk Aversion, Gender