An Experimental Comparison of Risky and Riskless Choice—Limitations of Prospect Theory and Expected Utility Theory

Abstract

Prospect theory, used descriptively for decisions under both risk and certainty, presumes concave utility over gains and convex utility over losses; a pattern widely seen in lottery tasks. Although such discontinuous gain-loss reference-dependence is also used to model riskless choices, only limited empirical evidence supports this use. In incentive-compatible experiments, we find that gain-loss reflection effects are not observed under riskless choice as predicted by prospect theory, even while in the same subjects gain-loss reflection effects are observed under risk. Our empirical results challenge the application of choice models across both risky and riskless domains. (JEL C91, D12, D81)