A Prospect Theory Model of Resource Allocation

Authors:
Philip Bromiley
Affiliations:
The Paul Merage School of Business, University of California, Irvine, Irvine, California 92697
Venue:
Decision Analysis
Year:
2009

Citing 9
Cited 1

Managerial perspectives on risk and risk taking

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Decision making over time and under uncertainty: a common approach

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Prospect Theory: Much Ado About Nothing?

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Shifts of Reference Points for Framing of Strategic Decisions and Changing Risk-Return Associations

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A Survey Study of Factors Influencing Risk-Taking Behavior in Real-World Decisions Under Uncertainty

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Violations of Cumulative Prospect Theory in Mixed Gambles with Moderate Probabilities

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Loss Aversion Under Prospect Theory: A Parameter-Free Measurement

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Risk Aversion in Cumulative Prospect Theory

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An Empirical Test of Gain-Loss Separability in Prospect Theory

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Decision Analysis

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Abstract

Many papers in organization theory and strategy use prospect theory, but few derive their hypotheses from prospect theory's formal model. This paper develops a prospect theory model of resource allocation under risk where projects have both positive and negative adjusted payoffs. The model assumes consistent value (rather than profit) maximizing behavior and demonstrates how resources, risk propensity, and reference levels interact to determine allocations to risky projects. The analysis shows that prospect theory's parameters interact in complex ways to influence risk taking, which makes simple predictions difficult. Overall, loss aversion and the reference point dominate the results, with curvature of the value function playing a secondary role and the maximum risk aversion occurring for firms near their reference points, not for firms above their reference points.