Gaussian Cumulative Prospect Theory

TL;DR

This paper introduces a new parametrization of Cumulative Prospect Theory tailored for Gaussian rewards, providing explicit valuation formulas that enable efficient computation and modeling of large populations.

Contribution

It develops a flexible, valid, and explicit Gaussian CPT parametrization with closed-form valuation, enhancing scalability and practical application in population modeling.

Findings

Explicit closed-form valuation for Gaussian gambles

Flexible parametrization capturing diverse behaviors

Efficient computation suitable for large-scale applications

Abstract

We propose a novel parametrization of Cumulative Prospect Theory (CPT), as developed by Daniel Kahneman and Amos Tversky, that yields an explicit gamble valuation formula for Gaussian reward distributions. Specifically, we define parametric functions $ v_{\theta} $, $ w^{-}_{\theta} $, and $ w^{+}_{\theta} $ satisfying three key properties. The first, \emph{validity}, ensures that for any parameter $\theta$, the functions conform to the qualitative principles of CPT: $ v_{\theta} $ is concave over gains and convex over losses with a steeper slope for losses; $ w^{-}_{\theta} $ and $ w^{+}_{\theta} $ are increasing, exhibit inverse S-shaped curves, and map 0 to 0 and 1 to 1. The second, \emph{richness}, guarantees that the parametrization is expressive enough to capture a wide range of behaviors: $ v_{\theta} $ can exhibit arbitrary asymptotic behavior and convergence rates, while $ w^{-}_{\theta} $ and $ w^{+}_{\theta} $ can achieve any specified crossover points and slopes. The third, \emph{explicit valuation}, ensures that for any $\theta$, the CPT valuation of a Gaussian-distributed gamble (with arbitrary mean and variance) can be computed in closed form -- enabling efficient approximations for bell-shaped reward distributions. This framework is designed for scalable and rapid computation, making it particularly suited for applications involving large populations. We demonstrate its practicality through two illustrative examples in population-level CPT modeling.