Expected utility versus cumulative prospect theory in an evolutionary model of bargaining

• Published in: Journal of economic dynamics & control Vol. 137; p. 104332
• Main Author: Khan, Abhimanyu
• Format: Journal Article
• Language: English
• Published: Elsevier B.V 01-04-2022
• Subjects: Bargaining; Cumulative prospect theory; Evolution; Expected utility; Loss-aversion; Probability-weighting; Reference-dependent preference; D01; C78; Reference-dependent preference; Cumulative prospect theory; Probability-weighting; Loss-aversion; Bargaining; Evolution; D90; Expected utility; D81; C73; D83
• ISSN: 0165-1889; 1879-1743
• DOI: 10.1016/j.jedc.2022.104332

I examine the effect of decision-making processes on the dynamics of bargaining over a fixed pie by comparing the share received when individuals are subject to reference-dependent preferences, loss-aversion, and probability-weighting, to the share they would receive on choosing by maximising expected utility instead. I show that: (i) reference-dependent preferences are unambiguously advantageous, (ii) loss-aversion does not have any effect, and (iii) probability-weighting is unambiguously disadvantageous. Finally, when these three features come together so that the decision-making process is described by cumulative prospect theory, then a higher share is obtained if and only if the advantage conferred by reference-dependent preferences is stronger than the disadvantage imposed by probability-weighting, and I present a precise necessary and sufficient condition that expresses this trade-off.