Empirical evaluation of third-generation prospect theory

Abstract

Third generation prospect theory (Schmidt et al. J Risk Uncertain 36:203–223, 2008) is a theory of choices and of judgments of highest buying and lowest selling prices of risky prospects, i.e., of willingness to pay (WTP) and willingness to accept (WTA). The gap between WTP and WTA is sometimes called the “endowment effect” and was previously called the “point of view” effect. Third generation prospect theory (TGPT) combines cumulative prospect theory for risky prospects with the theory that judged values are based on the integration of price paid or price received with the consequences of gambles. In TGPT, the discrepancy between WTP and WTA is due to loss aversion-losses have greater absolute utility than gains of the same value. TGPT was developed independently of similar developments by Birnbaum and Zimmermann (Organ Behav Hum Decis Process 74(2):145–187, 1998) and Luce (Utility of gains and losses: measurement-theoretical and experimental approaches. Erlbaum, Mahwah, 2000). This paper reviews theoretical and empirical findings, to show that TGPT fails as a descriptive model of both choices and judgments. Evidence refutes three implications of TGPT, but they are consistent with configural weight models (Birnbaum and Stegner, J Personal Soc Psychol 37:48–74, 1979) in which loss aversion is not needed to describe the results. In the configural weight models, buyers place greater weight on lower consequences, attributes or estimates of value compared to sellers, who place greater configural weight on higher aspects of an object or prospect.