New Concept for the Value Function of Prospect Theory

TL;DR

This paper proposes a novel concept for the value function in prospect theory, incorporating neuronal cusps to better model neural responses to gains and losses, with implications for understanding decision-making behavior.

Contribution

It introduces a new value function model featuring neuronal cusps, bridging neural responses and economic decision-making in prospect theory.

Findings

Neuronal responses to gains and losses differ significantly.

A cusp in the value function can explain abrupt decision changes.

The model aligns with recent neural studies on decision behavior.

Abstract

In the prospect theory, value function is typically concave for gains, commonly convex for losses, with losses usually having a steeper slope than gains. The neural system largely differs from the loss and gains sides. Five new studies on neurons related to this issue have examined neuronal responses to losses, gains, and reference points. This study investigates a new concept of the value function. A value function with a neuronal cusp may show variations and behavior cusps with catastrophe where a trader closes one's position.