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By

Fred Viole OVVO Financial Systems fred.viole@ovvofinancialsystems.com

And

David Nawrocki Villanova University Villanova School of Business 800 Lancaster Avenue Villanova, PA 19085 USA 610-519-4323 david.nawrocki@villanova.edu

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Embracing the Cognitive Dissonance Between Expected Utility Theory and Prospect Theory

Abstract

Initially noted with Allais' paradox in 1953 and further supported by Kahneman and Tversky in 1979, violations of expected utility theory and the associated biases individuals exhibit gave birth to a new paradigm of decision under uncertainty. These findings provided impetus to declare expected utility theory irrelevant. However, when investigating the violations to the violations of expected utility theory, we uncover deficiencies in the translation of the observed fourfold risk pattern to a twofold value function. We recreate the Allais paradox and prospect theory question set with updated amounts and percentages offering the survey online to willing global participants. We find subjective wealth to be the major determinant of risk-aversion and parity thereof between domestic United States and international responses. We also find location of residence to be a major influence on risk-aversion. Assuming the reflection effect of prospect theory, we are able to construct a fourfold utility function demonstrating both prospect theory and expected utility theory are quite relevant.

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Introduction As expected utility theory (EUT) has evolved through Bernoulli (1738,1954), von Neumann and Morgenstern (1944), Friedman and Savage (1948), and Markowitz (1952) to Allais’ paradox and prospect theory (PT) developed by Kahneman and Tversky, a number of disagreements with EUT have been brought forth by Allais (1953) and Kahneman and Tversky (1979). Equilibrium is defined as the condition of a system in which competing influences are balanced. Opposing views and theories can be seen in various fields offering convincing arguments and proofs for each viewpoint: such as the shape theory vs. the molecule vibration theory for how we smell1 or how two massive stars vs. a single dying star explain a supernova.2 Keynes vs. Hayek offer dueling theories in prescribing a remedy for an economic malaise. Is it possible when an equilibrium of theories exists, a greater understanding of the situation is revealed by accepting both theories conditionally? Quantum physics and general relativity exist simultaneously but there is some point at which the other fails however accurate they are in their own realm. That is precisely what is happening with expected utility theory (EUT) and its violations, most notably identified by prospect theory and cumulative prospect theory (singularly referred to as PT). Rather than the point of demarcation being sub-atomic sizes with the physical sciences, the line is drawn at the subjective level of total wealth for the individual in the social sciences. Quantum physics deals with chaotic particles, items and actions that do not appear to make sense through a general relativity lens. Think of PT as quantum physics, messy and chaotic due to underlying individual biases; and think of EUT as general relativity, much more orderly. We contend that the chaotic messes, or biases, in the PT literature (Certainty equivalence, loss aversion, ambiguity aversion, disposition effect among others have been developed by PT researchers) are inversely proportional to subjective wealth for the individual, thus leading to more orderly decisions under uncertainty for wealthier individuals.

1 http://sciencefocus.com/feature/space/how-we-smell-competing-theories 2 http://news.nationalgeographic.com/news/2007/11/071114-supernova.html

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Our goal in this paper is to determine whether EUT and PT can exist side by side, each offering valuable information about the behavior of individuals under uncertain conditions. We test this theory of equilibrium by recreating the prospect theory question set with varying amounts and certainty percentages using an online survey, and evaluating the responses. Under this structure we test a much greater discount to expected value for the certain outcome than presented by Allais (1953). We also decrease the percentages for prospect theory questions, directly offering what would be considered risk-seeking alternatives, rather than increased risk-aversion percentages as presented in Kahneman and Tversky (1979). This paper will present an overview of the literature of EUT and PT, describe our experiment, analyze the results, and end with our conclusions. Review of the Literature - Expected Utility Theory / Prospect Theory The Expect Utility Theory (EUT) axioms as developed by von Neuman and Morgenstern (1944) are: Independence – assumes that when two gambles are mixed with a third one, an individual will maintain the same preference order as when the two are presented independently. Completeness – assumes that an individual can always decide between two alternatives. Transitivity – assumes that an individual is consistent. If ApB (A is preferred to B) and BpC, then ApC. Continuity – assumes that if ApB and BpC, then there should be some combination of A and C where the individual will be indifferent between B and the combination of A and C. The key tenets of Prospect Theory (PT) developed by Kahneman and Tversky (1979) which distinguish it from EUT are: Preferences are described by an S-shaped value/utility function, V(x), with an inflection point at x=0 Risk aversion does not globally prevail – individuals are risk seeking regarding losses 4|Page

Individuals distort small probabilities Individuals make decisions based on change of wealth rather than total wealth “Framing” of alternatives affects individuals' choices

A discussion of these issues follows. The PT concepts are discussed in order while the appropriate EUT axiom follows the theme of the preceding PT discussion.

Preferences are described by an S-shaped value/utility function, V(x), with an inflection point at x = 0.

Since Bernoulli’s explanation of the St. Petersburg Paradox in 1738, utility theories have embraced the supposition that risk-aversion equals concavity of gains. The combination of the concavity of gains ideal with the convexity of losses as per PT yielded an S-shaped value function. This is in contrast to the Reversed S-shaped functions of Friedman and Savage (1948) and Markowitz (1952). As a result, Viole and Nawrocki (2011) normatively propose a combination of two autonomous reverse-S utility functions, which do indeed produce a convex-concave function centered around current wealth, for the interior section of the curve. This is consistent with the twofold PT value function. However, Viole and Nawrocki contend that each gain and loss function is itself a twofold function, ultimately yielding a fourfold function and the ratio of each function’s associated risk parameter (n for losses, q for gains) will dictate the overall level of risk aversion.3 This is consistent with the fourfold pattern of risk identified in PT. Figure 1 from Viole and Nawrocki (2011) graphically illustrates the fourfold construction. INSERT FIGURE 1 ABOUT HERE. Transitivity Axiom The transitivity axiom requires parameter stationarity and parameter stationarity infers that the multiperiod utility analysis is considered as a whole by the individual. This inference is in stark contrast to the myopic findings of Camerer (2005) in his multi-period utility experiment thus voiding the “game as

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The ratio of parameters n:q compares the steepness of the loss function to the steepness of the gain function. Lossaversion implies a steeper loss function or greater n:q ratio.

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a whole” consideration. “A striking fact about the loss-aversion in our savings experiment is that each subject made 29 periodic consumption decisions, over 7 lifetimes. So their earnings were determined by 203 different piecemeal decisions. They could easily afford to absorb point losses on many decisions and still end up ahead. The fact that they are reluctant to do so…means they are not only loss-averse (on an arbitrary utility scale)—they are myopically loss-averse to each of about 200 separate periods” (Camerer, 2005) This is equivalent to an infinite number of possible utilities based on an individual's frequency of observation and number of securities when dealing with continuous distributions – its state being indefinite until measured. A utility function should reflect an individual's heterogeneous relative risk aversion, locally and in the aggregate. This nonstationarity in the reference point challenges the transitivity axiom of EUT. Markowitz (2010) offers further support for nonstationarity by noting that “It does not violate the expected-utility hypothesis to assume that an agent's utility function changes with time.” Post et al. (2008) also note the nonstationarity of a reference point in their analysis of the game show “Deal or No Deal,” Risk aversion does not globally prevail – individuals are risk seeking regarding losses. Risk seeking with losses is clearly identified in PT. Payne, Laughhunn, and Crum (1981) perform experimental studies using managers as subjects, confirming the tendency towards risk-taking for losses, at least when ruin is not an issue. PT happens to neglect loss-aversion with losses or when “ruin is an issue.” This is the point below an acceptable level of loss which threatens existence, identified by Roy (1952) as the safety first level and later explained by Kahneman and Tversky (1979) as the [utility] difference between a loss of 100 and a loss of 200 appears greater than the difference between a loss of 1,100 and a loss of 1,200, unless the larger loss is ruinous. PT and other strictly concave gain functions have ignored risk seeking with gains, or what Thaler and Johnson (1990) dubbed the “house-money 6|Page

effect.” The further wealth extends beyond the upside target the more influence EUT exerts on the decision maker. Post and Levy (2005) deconstruct the risk-averse and risk-seeking attributes into four behaviors: (1) risk aversion for losses, (2) risk seeking for losses, (3) risk aversion for gains, and (4) risk seeking for gains (See Figure 1 again). Individuals distort small probabilities. PT notes a fourfold pattern of weighting functions under a twofold value function, convex (losses) – concave (gains). The neglect of the outer points of gains and losses is rationalized by their “low probabilities” by Kahneman and Tversky (1992). They note that a review of the experimental evidence confirm a distinctive fourfold pattern of risk attitudes: risk aversion for gains and risk seeking for losses of high probability; risk seeking for gains and risk aversion for losses of low probability. The most distinctive implication of prospect theory is the fourfold pattern of risk attitudes. For the non-mixed prospects used in their study, the shapes of the value and the weighting functions imply risk-averse and risk-seeking preferences, respectively, for gains and for losses of moderate or high probability. Furthermore, the shape of the weighting functions favors risk seeking for small probabilities of gains and risk aversion for small probabilities of loss. Viole and Nawrocki (2011) contend that the single reference point is responsible for the value function neglect of these “low probability” events. The use of two reference points will allow for the fourfold function: an upside target for the gain function and an acceptable level of loss for the loss function (something as temporal as an upside target limit order and a stop loss order investors typically utilize, based on heterogeneous discount rates/costs of capital) . For aggregate wealth, the benchmarks are the subsistence level (S) for losses and the personal consumption saturation point (PCS) for gains. Individuals make decisions based on change of wealth rather than total wealth. Wealth levels in PT have been addressed in historical research. As Post et al. (2008) found in their study of “Deal or No Deal” contestants that they are assumed to have a narrow focus and evaluate the 7|Page

outcomes in the game without integrating their initial wealth – a typical assumption in prospect theory. Furthermore, the correct measure of wealth should be lifetime wealth, including the present value of future income. However, lifetime wealth is not observable and it is possible that contestants do not integrate their existing wealth with the payoffs of the game. Therefore, they included initial wealth as a free parameter in their model. The free parameter leads to the non-intuitive answer in their study where the maximum likelihood estimators for wealth levels (W) in euros are Dutch (75,000), German (544), and US (102,000). The estimated coefficients for the German edition are quite different from the Dutch values. The optimal utility function reduces to the CARA exponential function (β = 0) and the estimated initial wealth level becomes insignificantly different from zero. Substituting extreme coefficient values to make the model fit lends support to the notion that nominal wealth is not the appropriate qualifier. PT loosely supports this supposition with its specification that individuals make decisions based on change of wealth rather than total wealth. However, if identical amounts were offered to a nominally wealthy individual and a nominally less wealthy individual, the change would be a reflection of the nominal wealth. Thus, PT does not escape the total wealth pitfall when comparing individual utilities even though they identify the subjective nature of wealth. Kahneman and Tversky (1979) conclude that the same level of wealth, for example, may imply abject poverty for one person and great riches for another – depending on their current assets. Continuity Axiom Aside from the multiple lottery probability juxtaposition, continuity has taken on another important connotation. Namely, that the individual’s utility function is one continuous function. The utility of a zero return has been assumed to be equal to zero by historical functions to preserve this notion. Fishburn and Kochenberger (1979) note a discontinuity at U(0) with their two-piece von Neumann-

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Morgenstern utility function,4 where P+ and E+ have a limiting form that is discontinuous at the origin with U(0) = 0 and U(x) = k > 0 for all x > 0. This arises from P+ when a1 = k and a2 goes to zero, and from E+ when b1 = k and b2 goes to infinity.” The discontinuity of the overall function at zero is important in identifying the “break even effect” (a positive utility) or an “opportunity cost” (a negative utility) from a zero return. Viole and Nawrocki (2011) prove how both PT and EUT compliant utility functions cannot generate these values under zero return scenarios without a discontinuous multiple reference point model. Completeness and Independence Axioms PT offers a compelling argument against the completeness axiom of EUT on the basis of heuristics, and against the independence axiom based on the qualification of choice as a contingent process. Kahneman and Tversky (1992) conclude: “Theories of choice are a best approximate and incomplete. One reason for the pessimistic assessment is that choice is a constructive and contingent process. When faced with a complex problem, people employ a variety of heuristic procedures in order to simplify the representation and the evaluation of prospects. These procedures include computational shortcuts and editing operations, such as eliminating common components and discarding nonessential differences… . The heuristics of choice do not readily lend themselves to formal analysis because their application depends on the formulation of the problem, the method of elicitation, and the context of choice.” Post et al. (2008) offer further empirical evidence supporting path-dependence with their analysis of the game show “Deal or No Deal” and found that reference-dependent choice theories such as prospect

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P+ = a1 xa2 E+ = b1 (1- e-b2x)

for all x ≥ 0 for all x ≥ 0

where x is the investment, P+ is the power utility function, a1 and a2 are the gain seeking parameters for the power function, E+ is the exponential utility function, b1 and b2 are the gain seeking parameters for the exponential function.

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theory suggest that path-dependence is relevant, even when the choice problems are simple and welldefined, and when large real monetary amounts are at stake.” “Framing” of alternatives affects individuals' choices. This seminal discovery of framing may have its roots firmly planted in EUT soil. Shefrin (2001) traces the history of framing, one of PT’s main tenets, to Markowitz (1952). Shefrin reviews the literature and finds that the concepts of gains and losses with respect to a reference point, and a utility function with convex and concave segments are originally proposed in Markowitz (1952). Shefrin notes the ideas introduced in Markowitz (1952) were later developed into prospect theory by Kahneman and Tversky (1979). PT draws on Markowitz for the concepts of framing, gains, losses, reference points, and a utility function with concave and convex segments. PT also draws on Allais for its treatment of probabilities. Methodology We conducted an online survey in December 2011to test the explanatory power of subjective wealth for decision making under uncertainty. We constructed 18 questions - 8 of which were direct choice questions involving payoffs and probabilities, accompanied with 8 questions of the subjective amounts that influenced the prior decision. In addition to considering the varying amounts, we asked the respondents to provide the state of residence within the US (or country if outside the US) and how they would qualify their wealth level. We avoided additional demographic questions such as wealth, income levels, gender and age because participants may not complete the survey if asked. This additional information was not needed as the goal of the study is to show how subjective wealth influences the certainty equivalence and concavity of the gain function. Our survey is derived from the situations presented by PT as developed by Kahneman and Tversky (1979), which in turn were inspired by Allais (1953). The methodology was similar to those studies - situations of varying amounts and percentages are simultaneously offered for the respondent to select. Allais’ sample of respondents was 10 | P a g e

an informal survey of his associates, and Kahneman and Tversky’s sample consisted of an experiment with compensated students. Johnson & Bickel (2002) found no systematic differences between real and hypothetical rewards; and Rieger, Wang and Hens (2011) note that any concerns with surveys are far outweighed by the possibility to obtain a large sample without the usual self-selection bias that surveys frequently show. Our survey was initially sent to participants in various investment discussion groups on the internet but we were fortunate that several finance and investment blogs on the Internet took an interest in the survey and asked their substantial followings (both domestic and international) to participate. Incomplete surveys were not counted and respondents were only allowed to participate once from the same IP address to avoid ballot stuffing. This was accomplished within the settings of an online survey service which generated a URL address for us to then solicit responses. This genuine willing participation also differentiates us from historical classroom studies whereby students were minimally compensated for their participation. Our sample was truly global with 376 responses (with 247 from the U.S. and 129 international), with the Internet affording a heterogeneity of participants not enjoyed by earlier studies. All respondents had to understand English to take the survey. Due to the survey being conducted through financial blogs, we have a higher proportion of qualified individual and institutional investors than previous studies. We are keenly aware of the reliance on hypothetical choices and echo the thoughts of Kahneman and Tversky (1979), “The use of the method relies on the assumption that people often know how they would behave in actual situations of choice, and on the further assumption that the subjects have no special reason to disguise their true preferences.” Further study of participant demographics is a possible area of future research as well as the use of experiments rather than a survey. Furthermore, we offered the survey in both ascending and descending amounts to observe any path-dependence of choices. 11 | P a g e

While the design of our study was similar to PT, the specifics were inversely related: PT tested riskaversion using percentages and expected values; we tested risk seeking behavior. See Appendix A for the survey questions. In Table 1a in Appendix A, questions 3, 7, 11 and 15 are the “Allais” question set while Questions 5, 9, 13, and 17 are the “Prospect Theory” question set. Our goal was to demonstrate that the biases and violations of EUT are guided by the individual's subjective wealth qualification. We achieved this by blending the situations presented by Allais, which Kahneman and Tversky described as “extremely large gains,” and the “moderate amounts” offered in PT. We also blended the levels of certainty presented in the two historical surveys. Table 1 illustrates the amounts, percentages, expected values used in studies designed for Allais, PT, and our survey. Allais' 1953 famous situation ($100 million francs with certainty [E(x) = $100 million francs] or an 89% chance of $100 million francs; 10% chance of $500 million francs; and 1% chance at nothing [E(x)=$139 million francs]) shows how the certain outcome will overcome discounts to expected values (28% in Allais' instance) whenever a certain outcome is compared to an alternative without certainty. Our goal was to see how far this certainty equivalence would go across various levels of outcomes, not just the “extremely large.” Our expected value discount for the certain outcome (50%) was much more pronounced than Allais (28%), and PT (0.38%).5 INSERT TABLE 1 ABOUT HERE Our second set of outcomes per Allais was to remove the certain outcome. We believe that the outcome ratios in Allais are more relevant than those surveyed in PT. More distorted percentages can be offered to yield the approximate expected value per PT, thus encompassing different wealth classifications with the same situation. For example, PT asks if the respondent would prefer a 45% chance at 6,000 and a 55% chance of nothing [E(x)=2,700] or a 90% chance of 3,000 and a 10% chance of nothing [E(x)=2,700]. PT then asks in Problem 8 if the respondent would prefer a 0.1%

5 Problem 1 as per Kahneman and Tversky (1979) which is illustrated in Table 1.

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chance at 6,000 else nothing [E(x)=6] or a 0.2% chance at 3,000 else nothing [E(x)=6].6 We combined these two propositions (with a risk-seeking bias versus PT) and asked if the respondent would prefer a 50% chance of $200 or else nothing [E(x)=$100]; or a 9% chance of $1,120 or else nothing [E(x)=$100.80]. The expected values then increase over the next three sets of outcomes as outlined in Table 1. Our risk-seeking choice amounts are 5x the risk-averse alternative, consistent with Allais. The percentages attached to these outcomes are aligned with PT and Allais – a 50% / 50% situation (45% / 55% for PT) and a 9% / 91% risk-seeking situation (10% / 90% for Allais). Our median situation was approximately the per capita GDP figure for the U.S., i.e. $50,000. Both ends of the income spectrum were considered with certain amounts offered ranging from $200 through $50 million. We tested the theory for gains with the assumption that the inverse will hold with losses. PT offers some empirical support for this assumption coining the term “reflection effect,” “In each of the four problems… the preference between negative prospects is the mirror image of the preference between positive prospects. Thus, the reflection of the prospects around 0 reverses the preference order. We label this pattern the “reflection effect”. (Kahneman and Tversky, 1979). Results “Now it is highly probable that any increase in wealth, no matter how insignificant, will always result in an increase in utility which is inversely proportionate to the quantity of goods already possessed.” (Bernoulli, 1738) Under our fourfold utility function, we would expect that as wealth increases, Allais’ certainty effect would decrease. We would also expect increased risk seeking with gains as subjective wealth increases for situations devoid of a certain outcome. We found that subjective wealth and state GDP of residence positively correlated to an individual's risk-seeking preferences.

6 Problem 8 is interesting in that the PT results actually support EUT. This violation of the violation to EUT is argued away with the perverse explanation that, “However, the function is not well-behaved near the endpoints, and very small probabilities can be either greatly overweighted or neglected altogether.” (Kahneman and Tversky, 1992)

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Certainty Effect There is some point of asymmetry of payouts that negates the certainty effect, even for the “Less Wealthy”. This point appears to be a 50% discount to expected value for the certain outcome. Questions 3, 7, 11 and 15 on our survey (questions 17, 13, 9, and 5 respectively for the descending amount version) offer varying amounts of certain outcomes, all at a 50% discount to expected value. The data are convincing: a majority of all wealth levels selected the less certain outcome, while approximately 60% chose the certain $50 million. The Allais' discount was 28%, and this was not enough to dissuade a majority to select the certain outcome. PT’s discount to the certain outcome was 0.38%, essentially the same expected value for each outcome, thus yielding similar results to Allais.7 Our results refute the generalization of these observations for the two levels of outcomes, the “exceptionally large” for Allais and the “moderate” for PT. Rather, the certainty effect is clearly governed by the expected value discount for the certain outcome. Some of the more significant results follow: State of Residence The average risk-averse response from an “Of Average Wealth” individual residing in a less wealthy US state was 67.9%. The average risk-averse response from an “Of Average Wealth” individual residing in a wealthy US state was 54.5%. Path-Dependence The average risk-averse response from “Wealthy” global respondents for ascending amounts was 34.2%

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The average risk-averse response from “Wealthy” global respondents for descending amounts

Table 1 notes the expected value differences for PT under “Set 1 of Choices - Certainty.” The expected value for the certain outcome is 2,400 while the expected value for the non-certain outcome is 2,409. This PT question was designed to isolate certainty equivalence effects via percentages; while Allais (1953) was designed to highlight the certainty equivalence difference via amounts and percentages.

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was 46.1% Global Risk-Aversion Parity The average risk-averse response from US respondents was 53.4% The average risk-averse response from international respondents was 53.6%

OECD vs. Non-OECD Countries The average risk-averse response from a Non-OECD country was 59.0% The average risk-averse response from an OECD country was 54.1%

Further debunking the concavity of gains notion are the data from the questions 4, 6, 8, 10, 12, 14, 16, and 18, which asked the question “The amount that influenced my decision was.” If a utility function is sufficiently concave, then the amount of utility between $50 million and $280 million would be negligible, a fraction of a util as noted and supported by Kahneman and Tversky (1979): “Thus the difference in value between a gain of 100 and a gain of 200 appears to be greater than the difference between a gain of 1,100 and a gain of 1,200.” In evaluating the responses of the risk-seeking outcome between a 9% chance of $280 million versus a 50% chance of $50 million, a light is shed on the convexity of gains. When asked what amount influenced their risk-seeking decision, 25% “Less Wealthy” responded $280 million while 66.7% of “Wealthy” individuals responded $280 million. This suggests that there is a substantial difference in utility (convexity) for $280 million versus $50 million, especially since the percentages are 9% and 50% respectively for their outcome. It also illustrates the non-stationarity of that convexity with subjective wealth. Similar differences in percentages were observed for the lesser amounts as well. INSERT FIGURE 2 ABOUT HERE Figure 2 is the percentage of risk-averse selections of global respondents for the “Allais” question set (Questions 3, 7, 11 and 15 as listed in Appendix A are the “Allais” question set). The 15 | P a g e

expected values for each questions’ certain outcome increase from $200, to $4,200, to $50,000, to $50 million. . The distinction among each of the wealth qualification’s responses in Figure 2 is telling. It is clear that as subjective wealth increases, the overall level of risk-aversion is lower. However, this does not contradict PT and its finding that individuals make decisions based on change of wealth (assuming the subjective wealth classification matches the respondents’ nominal wealth). Our survey results show that the change in wealth for like amounts is less for a nominally wealthy individual. We too would have expected a convergence of these responses for all groups when the expected value for the certain outcome is $50 million. Our results do show some convergence, but a serious discrepancy still exists between the three groups. Is a $50 million certain change-of-wealth that dissimilar from an event for any level of wealth? In this instance, for PT to hold, the answer would have to be yes - due to extreme nominal wealth present in the sample. Another convergence that should be witnessed is with the third “Allais” question for “Of Average Wealth” and “Less Wealthy” respondents. According to our results, a $50,000 certain change– in-wealth is vastly different for each of these groups, even though it represents the median annual income in the US. A better explanation for this observed divergence is nominal wealth. We would have expected this divergence as the change-of-wealth would be less for the wealthy (nominal) than the average wealth (nominal) individual. Thus, there must be some nominal wealth influence on the classifications. Finally we would have expected a convergence of responses with the first “Allais” question for all respondents, as a $200 change in wealth would represent similarly miniscule percentages for all wealth. We did not see this convergence and the “Wealthy” are distinctly more risk seeking. Again for PT to hold, the percentages of wealth represented by the $200 certain outcome would have to be vastly different if individuals make decisions based solely on change in wealth. INSERT FIGURE 3 ABOUT HERE 16 | P a g e

Figure 3 is the percentage of risk-averse selections of global respondents for the “Prospect Theory” question set.8 Each “Prospect Theory” question has almost identical expected values for each situation presented that increase from $100, to $2,100, to $25,000, to $25 million. It is also clear that as subjective wealth increases, the overall level of risk-aversion is lower. Again, this does not contradict PT and its finding that individuals make decisions based on change of wealth. However, per PT, we would expect a convergence of the responses between all groups when the expected value is $25 million. There is minimal convergence as the amounts increase which does not support the notion of a concave utility for gains. These results provide an argument that customary wealth, per Markowitz (1952), equals current wealth even in the case of a recent windfall gains or losses. Markowitz (2010) summarizes as follows: “Markowitz (1952) hypothesizes that this inflection point was located at the agent’s ‘customary wealth,’ which equaled current wealth except in the case of recent windfall gains and losses. In the case of a recent windfall gains, the agent’s current wealth would move temporarily into the convex portion of the curve to the right of the inflection point. As a result, the agent would become more carefree in his or her risk taking... Conversely, in case of a windfall loss, the agent would move temporarily into the concave region to the left of the inflection point and act more cautiously.” The transition from “Less Wealthy” to “Wealthy” cannot be assumed to be an act of a recent windfall for those whom qualify themselves as such nor be considered retractable for a windfall gain absent any external influences. The data support the likely migratory progression of customary wealth, with noticeable reductions in risk-aversion for each qualification. INSERT FIGURE 4 ABOUT HERE Figure 4 is the cumulative average number of optimal outcomes each group selected. The

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Questions 5, 9, 13, and 17 in Table 1a in Appendix A are the “Prospect Theory” question set.

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optimal outcome is defined as the highest possible overall nominal outcome, regardless of probabilities. “Situation B” was the consistent highest nominal outcome in each question and each response for “Situation B” received one point. “Situation A” responses received zero points. The highest possible score is eight points, consistently selecting “Situation B” for each situation presented. In decisions under uncertainty, it is clear that subjective wealth is relevant in deviations from a nominally optimal outcome. Moreover, the higher nominal outcome for “Situation B” argues convexity of utility for those amounts (given that the higher amounts were 5x the alternatives). As subjective wealth increases, so does the proximity to a nominally optimal outcome casting further doubt on the law of diminishing marginal utility of money and its associated concave utility function. Remember, we offered amounts of the very small and the exceptionally large in order to bring parity to the three groups and support the “change-of-wealth” argument; yet the subjective wealth qualification would not comply. Explanations Using the concave-convex utility function for gains in Figure 5 we are able to illustrate the relative positioning of the subjective wealth groups to their PCS level. The “Less Wealthy” are typically guided by the concavity of the total wealth function for local choices, as they are furthest from their PCS level. This is fully consistent with the results presented here and in PT. However, when wealth increases and the PCS level is eclipsed, the “Wealthy” enjoy a convex utility or economies of scale for additional resources. The migration of positioning explains the nonstationarity of loss-aversion as the marginal dollar gained is larger than the marginal dollar lost for the “Wealthy.” Again, the total subjective wealth influences the change in wealth of the decision, neither is exclusive per EUT and PT. INSERT FIGURE 5 ABOUT HERE Viole and Nawrocki (2011) illustrate an autonomous gain and loss utility function. We use this 18 | P a g e

nonlinear function to demonstrate how different local utilities are experienced from identical amounts when the aggregate subjective wealth of the individual is the only distinction. Table 2 uses the gain function to exemplify the utilities of gains according to the subjective wealth positions in Figure 5.

INSERT TABLE 2 ABOUT HERE Using the conditional marginal utility equation with nonstationary benchmarks (Viole and Nawrocki 2011), we analyze the difference in local utilities for the amounts 50 and 280 for all three subjective wealth groups. Assuming equal gain seeking appetite for all three groups, we can see how the concavity of the function below the benchmark influences the “Less Wealthy” and “Of Average Wealth.” Our function is consistent with Bernoulli’s observation that “any increase in wealth, no matter how insignificant, will always result in an increase in utility which is inversely proportionate to the quantity of goods already possessed,” with U(50) = 550 for the “Less Wealthy;” U(50) = 350 for the “Of Average Wealth,” and the U(50) = 150 for the “Wealthy” when q = 1 for all groups.9 However, when evaluating the difference in utilities of the two outcomes we can see how the larger amount will offer a greater relative utility to the “Wealthy” with a 5.6x increase in amounts translating to a 220% larger associated utility. For the “Less Wealthy,” the same 560% increase in amounts translates to a 41.8% higher utility and 65.7% higher utility for the “Of Average Wealth” - due entirely to their aggregate wealth position relative to their PCS. The [PCS – Wealth] is assumed to be 500 for the “Less Wealthy,” 300 for the “Of Average Wealth,” and 100 for the “Wealthy” as identified by the normative positions in Figure 4. This evaluation of utilities is consistent with the results from Chart 3. In evaluating the questions 4, 6, 8, 10, 12, 14, 16, and 18, “The amount that influenced my decision,” we can ascribe a gain-seeking exponent q to each selection. If “0” was the influencing amount, that

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Cardinality holds IFF parameters q, l, a are identical between comparisons.

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infers linearity or indifference for gains, thus q = 1. If the lower amount was selected then q = 2; and finally q = 3 for the largest amount selected. INSERT TABLE 3 ABOUT HERE We can see from Table 3 the percentage each group selected as the amount that influenced their decision for each question. The average gain seeking exponent q for each group is “Less Wealthy” “Of Average Wealth” “Wealthy” 1.938 2.079 2.274

This validates the notion that as subjective wealth increases, the gain seeking exponent q increases as well, thus creating steeper utility functions for gains locally at time t, for increased subjective wealth. Conclusions Concavity of gains and the law of diminishing marginal utility for money was a shortsighted solution to a hypothetical lottery paradox which is anything but paradoxical. The St. Petersburg Paradox is not a paradox when one considers ambiguity aversion coincidentally with loss-aversion. Concavity is not a practical solution as to why people refuse to pay amounts commensurate with an infinite expected value payoff. A better explanation rests in the inherent uncertainty of the gamble and participants’ inability to derive a specific expected value, not that the eventual large payoff is not worth as much. The concavity of gains does hold for tangible utility, i.e. one can only eat and drink so much (a notion more aptly associated with the less wealthy, hence the influence). However, money has a distinct intangible quality that enjoys an economies-of-scale convexity when used for purposes such as philanthropy. As subjective wealth increases, the satiation level simultaneously approaches thus diminishing the influence of tangible utility. Risk-aversion is easily identified in such convex utility functions with the concave loss section having a steeper curve than the corresponding convexity of gains. 20 | P a g e

“Thus, though a poor man generally obtains more utility than does a rich man from an equal gain, it is nevertheless conceivable, for example, that a rich prisoner who possesses two thousand ducats but needs two thousand ducats more to repurchase his freedom, will place a higher value on the gain of two thousand ducats than does another man who has less money than he. Though innumerable examples of this kind may be constructed, they represent exceedingly rare exceptions” (Bernoulli, 1738). It is not an exceedingly rare exception; rather it is a consistent observation. The rich man is afforded the luxury of maximizing expected utility – thus not becoming increasingly risk-averse. This directly challenges the thoughts of Bernoulli and the notion of a strictly diminishing marginal utility of money. Negating the implied increasing relative risk aversion of Bernoulli does not indirectly prove a diminishing relative risk aversion. The subjective nature of the wealth qualification and influences of other factors, such as state of residence, undermine the monotonicity of the constant relative risk aversion featured in PT. Initially noted with Allais' paradox in 1953 and further supported by Kahneman and Tversky in 1979, violations of EUT and the associated biases individuals exhibit gave birth to a new paradigm of decision under uncertainty. “The preceding discussion reviewed several empirical effects which appear to invalidate expected utility theory as an empirical model” (Kahneman and Tversky, 1979), while Levy and Levy (2002) alternatively find, “when the two competing theories of the S-shaped function and the reverse S-shaped function race head to head, 76% of the choices conform with the reverse Sshaped functions and contradict the S-shaped functions.” The sample population of PT may have biased the biases. We intentionally avoided the relative homogeneity of a student population by offering the survey to all willing participants globally. We noted some path-dependence in the results, partially supporting the argument presented in Post et Al. (2008). However, their treatment of the wealth parameter is reminiscent of the dual wealth 21 | P a g e

argument in PT, “The emphasis on changes as the carriers of value should not be taken to imply that the value of a particular change is independent of initial position. Strictly speaking, value should be treated as a function in two arguments: the asset position that serves as a reference point, and the magnitude of the change (positive or negative) from that reference point. An individual’s attitude to money, say, could be described by a book, where each page presents the value function for changes at a particular asset position. Clearly the value functions described on different pages are not identical: they are likely to become more linear with increases in assets. However, the preference order of prospects is not greatly altered by small or even moderate variations in asset position” (Kahneman and Tversky, 1979). The identification of failed convergences of responses for the extremely small and extremely large outcomes refutes the “change in wealth, not total wealth” argument. However, the nominal influence on the classifications supports the “change in wealth, not total wealth” argument for moderate amounts. The consistency observed was the subjective wealth argument, illustrating that preference order of prospects is altered by small and moderate variations in asset position relative to the individual’s PCS level. We have provided empirical support for the discontinuous multiple heterogeneous reference point model normatively proposed in Viole and Nawrocki (2011). This theory satisfies both competing theories conditional on the individual's total subjective wealth.

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References Allais, M. (1953). “Le Comprotement de l’homme rationnel devant le risqué: critique des postulants et axioms de l’ecole americaine.” Econometrica, XXI:503-546. Bernoulli, D. (1738, 1954). “Exposition of a New Theory on the Measurement of Risk.” Econometrica, 22, 23-36. Camerer, C. (2005). “Three Cheers – Phychological, Theoretical, Empirical – for Loss Aversion.” Journal of Marketing Research, 42 (2). 129 – 133. Fishburn, Peter C. and Gary A. Kochenberger. (1979). “Two-Piece von Neumann-Morgenstern Utility Functions,” Decision Sciences, v10, 503-518. Johnson, M. W. & Bickel, W. K. (2002), `Within-subject comparison of real and hyperthetical money rewards in delay discounting', Journal of the Experimental Analysis of Behavior 77, 129-146. Kahneman, D., and A. Tversky. (1979). “Prospect Theory: An Analysis of Decision Under Risk.” Econometrica, 47(2), pp. 263-291, March 1979. Kahneman, D., and A. Tversky. (1992). “Advances in Prospect Theory: Cumulative Representation of Uncertainty.” Journal of Risk and Uncertainty, 5:297 – 323. Lopes, L. L., and G. C. Oden. (1999). "The Role of Aspiration Level in Risk Choice: A Comparison of Cumulative Prospect Theory and SP/A Theory." Journal of Mathematical Psychology, 43, 286-313. Levy, Moshe and Haim Levy. (2002). “Prospect Theory: Much Ado About Nothing,” Management Science, v48(10), 1334-1349. Levy, Moshe and Haim Levy. (2004). “Prospect Theory and Mean-Variance Analysis.” The Review of Financial Studies, v17(4), 1015-1041. Markowitz, H. (1952). “The Utility of Wealth." Journal of Political Economy, 60, 151-158. Markowitz, H. (1959). Portfolio Selection: Efficient Diversification of Investments. Markowitz, H. (2010). “Porfolio Theory: As I Still See It.” Annual Review of Financial Economics, v2, 1-41. Post, T., and H. Levy. (2005). “Does Risk Seeking Drive Asset Prices? A Stochastic Dominance Analysis of Aggregate Investor Preferences and Beliefs.” The Review of Financial Studies, v18(3), 925-953. Post, T., M. Van den Assem, G. Baltussen, and R. Thaler. (2008). “Deal or No Deal? Decision Making under Risk in a Large-Payoff Game Show.” American Economic Review, March 2008, (98:1), 3871.

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Rieger, M., Wang, M., and Hens, T. (2011). “Prospect Theory Around the World.” Available at http://ssrn.com/abstract=1957606.

Roy, A. D. (1952). "Safety-First and the Holding of Assets." Econometrica, 20, 431-449. Shefrin, H. (2001). Behavioral Finance (The International Library of Critical Writings in Financial Economics). Edward Elgar Pub. (December 30, 2001). Tversky, A. (1969). “The Intrasitivity of Preferences.” Psychology Review, 76, 31–48. Thaler, R. and E. Johnson. (1990). “Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice” Management Science, June 1990 vol. 36, no. 6, 643660. Viole, Fred, and David Nawrocki. (2011). “The Utility of Wealth in an Upper and Lower Partial Moment Fabric.” Journal of Investing, Summer 2011, Vol. 20, No. 2, 58-85. von Neumann, John and Oskar Morgenstern. (1944), Theory of Games and Economic Behavior, Princeton University Press.

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Appendix A Our survey questions are reproduced below. Participants were shown one question at a time in order to placate the myopic decision making process. Questions 3, 7, 11, and 15 are the “Allais” question set while questions 5, 9, 13 and 17 are the “PT” question set.

The questions posed to respondents in both ascending and descending amounts. 1. I live in _____(state). If outside the US please provide country of residence. 2. I consider myself to be a. Less Wealthy b. Of Average Wealth c. Wealthy 3. Do you prefer situation A or situation B? a. Situation A: 100% Certainty to receive $200. b. Situation B: 22% chance to receive $200; 77% chance to receive $1,120, 1% chance to receive nothing. 4. The amount that influenced my decision was a. 0 b. 200 c. 1,120 d. Other (Please specify)_____ 5. Do you prefer situation A or situation B? a. Situation A: 50% chance to receive $200; 50% chance to receive nothing. b. Situation B: 9% chance to receive $1,120; 91% chance to receive nothing. 6. The amount that influenced my decision was a. 0 b. 200 c. 1,120 d. Other (Please specify)_____ 7. Do you prefer situation A or situation B? a. Situation A: 100% certainty to receive $4,200. b. Situation B: 22% chance to receive $23,520; 77% chance to receive $4,200; 1% chance to receive nothing. 8. The amount that influenced my decision was a. 0 b. 4,200 c. 23,520 d. Other (Please specify)_____ 25 | P a g e

9. Do you prefer situation A or situation B? a. Situation A: 50% chance to receive $4,200; 50% chance to receive nothing. b. Situation B: 9% chance to receive $23,520; 91% chance to receive nothing. 10. The amount that influenced my decision was a. 0 b. 4,200 c. 23,520 d. Other (Please specify)_____ 11. Do you prefer situation A or situation B? a. Situation A: 100% certainty to receive $50,000. b. Situation B: 22% chance to receive $280,000; 77% chance to receive $50,000, 1% chance to receive nothing. 12. The amount that influenced my decision was a. 0 b. 50,000 c. 280,000 d. Other (Please specify)_____ 13. Do you prefer situation A or situation B? a. Situation A: 50% chance to receive $50,000; 50% chance to receive nothing. b. Situation B: 9% chance to receive $280,000; 91% chance to receive nothing. 14. The amount that influenced my decision was a. 0 b. 50,000 c. 280,000 d. Other (Please specify)_____ 15. Do you prefer situation A or situation B? a. Situation A: 100% certainty to receive $50 million. b. Situation B: 22% chance to receive $280 million; 77% chance to receive $50 million, 1% chance to receive nothing. 16. The amount that influenced my decision was a. 0 b. 50 million c. 280 million d. Other (Please specify)_____ 17. Do you prefer situation A or situation B? a. Situation A: 50% chance to receive $50 million; 50% chance to receive nothing. b. Situation B: 9% chance to receive $280 million; 91% chance to receive nothing.

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18. The amount that influenced my decision was a. 0 b. 50 million c. 280 million d. Other (Please specify)_____

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Appendix B – Response Data from All Respondents - Global [N=376] [Ascending %] [Descending %]

Question 2: Less Wealthy Of Average Wealth Wealthy Question 3: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 5: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 7: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 9: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 11: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 13: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 15: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 17: Less Wealthy ** Of Average Wealth ** Wealthy ** ** 1% Significance

Percent Respondents 24.20% 58.24% 17.55% Risk-averse [E(x)=200] 23.08% 13.70% 10.61% Risk-averse [E(x)=100] 68.13% 61.19% 54.55% Risk-averse [E(x)=4,200] 28.57% 20.55% 18.18% Risk-averse [E(x)=2,100] 76.92% 73.06% 57.58% Risk-averse [E(x)=50,000] 37.36% 27.85% 25.76% Risk-averse [E(x)=25,000] 91.21% 84.02% 74.24% Risk-averse [E(x)=50 million] 62.64% 56.16% 48.48% Risk-averse [E(x)=25 million] 96.70% 90.87% 83.33%

Ascending Descending 17.86% 8.45% 3.85% 25.40% 16.22% 15.00%

Risk Seeking [E(x)=400.40] 76.92% 86.30% 89.39% Risk Seeking [E(x)=100.80] 31.87% 38.81% 45.45% Risk Seeking [E(x)=8,408.40] 71.43% 79.45% 81.82% Risk Seeking [E(x)=2,116.80] 23.08% 26.94% 42.42% Risk Seeking [E(x)=101,000] 62.64% 72.15% 74.24% Risk Seeking [E(x)=25,200] 8.79% 15.98% 25.76% Risk Seeking [E(x)=101 million] 37.36% 43.84% 51.52% Risk Seeking [E(x)=25.2 million] 3.30% 9.13% 16.67%

Ascending Descending 82.14% 91.55% 96.15% 74.60% 83.78% 85.00%

85.71% 71.83% 53.85%

60.32% 56.08% 55.00%

14.29% 28.17% 46.15%

39.68% 43.92% 45.00%

25.00% 16.90% 3.85%

30.16% 22.30% 27.50%

75.00% 83.10% 96.15%

69.84% 77.70% 72.50%

89.29% 76.06% 61.54%

71.43% 71.62% 55.00%

10.71% 23.94% 38.46%

28.57% 28.38% 45.00%

28.57% 15.49% 15.38%

41.27% 33.78% 32.50%

71.43% 84.51% 84.62%

58.73% 66.22% 67.50%

89.29% 83.10% 65.38%

92.06% 84.46% 80.00%

10.71% 16.90% 34.62%

7.94% 15.54% 20.00%

50.00% 59.15% 38.46%

68.25% 54.73% 55.00%

50.00% 40.85% 61.54%

31.75% 45.27% 45.00%

92.86% 88.73% 65.38%

98.41% 91.89% 95.00%

7.14% 11.27% 34.62%

1.59% 8.11% 5.00%

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Domestic US Respondents [N=247]

Question 2: Less Wealthy Of Average Wealth Wealthy Question 3: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 5: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 7: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 9: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 11: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 13: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 15: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 17: Less Wealthy ** Of Average Wealth ** Wealthy ** ** 1% Significance

Percent Respondents 21.86% 59.11% 19.03% Risk-averse [E(x)=200] 20.37% 13.01% 10.64% Risk-averse [E(x)=100] 64.81% 60.96% 53.19% Risk-averse [E(x)=4,200] 25.93% 16.44% 19.15% Risk-averse [E(x)=2,100] 77.78% 74.66% 57.45% Risk-averse [E(x)=50,000] 33.33% 26.71% 27.66% Risk-averse [E(x)=25,000] 94.44% 86.30% 74.47% Risk-averse [E(x)=50 million] 61.11% 58.22% 48.94% Risk-averse [E(x)=25 million] 98.15% 91.78% 85.11%

Ascending Descending 14.29% 11.36% 6.67% 22.50% 13.73% 12.50%

Risk Seeking [E(x)=400.40] 79.63% 86.99% 89.36% Risk Seeking [E(x)=100.80] 35.19% 39.04% 46.81% Risk Seeking [E(x)=8,408.40] 74.07% 83.56% 80.85% Risk Seeking [E(x)=2,116.80] 22.22% 25.34% 42.55% Risk Seeking [E(x)=101,000] 66.67% 73.29% 72.34% Risk Seeking [E(x)=25,200] 5.56% 13.70% 25.53% Risk Seeking [E(x)=101 million] 38.89% 41.78% 51.06% Risk Seeking [E(x)=25.2 million] 1.85% 8.22% 14.89%

Ascending Descending 85.71% 88.64% 93.33% 77.50% 86.27% 87.50%

85.71% 75.00% 46.67%

57.50% 54.90% 56.25%

14.29% 25.00% 53.33%

42.50% 45.10% 43.75%

21.43% 11.36% 6.67%

27.50% 18.63% 25.00%

78.57% 88.64% 93.33%

72.50% 81.37% 75.00%

92.86% 84.09% 60.00%

72.50% 70.59% 56.25%

7.14% 15.91% 40.00%

27.50% 29.41% 43.75%

35.71% 11.36% 26.67%

32.50% 33.33% 28.13%

64.29% 88.64% 73.33%

67.50% 66.67% 71.88%

100.00% 88.64% 66.67%

92.50% 85.29% 78.13%

0.00% 11.36% 33.33%

7.50% 14.71% 21.88%

50.00% 59.09% 40.00%

65.00% 57.84% 53.13%

50.00% 40.91% 60.00%

35.00% 42.16% 46.88%

92.86% 90.91% 66.67%

100.00% 92.16% 93.75%

7.14% 9.09% 33.33%

0.00% 7.84% 6.25%

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International Respondents [N= 129]

Question 2: Less Wealthy Of Average Wealth Wealthy Question 3: Less Wealthy ** Of Average Wealth ** Wealthy * Question 5: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 7: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 9: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 11: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 13: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 15: Less Wealthy ** Of Average Wealth ** Wealthy ** Question 17: Less Wealthy ** Of Average Wealth ** Wealthy ** * 5% Significance ** 1% Significance

Percent Respondents 28.68% 56.59% 14.73% Risk-averse [E(x)=200] 27.03% 15.07% 10.53% Risk-averse [E(x)=100] 72.97% 61.64% 57.89% Risk-averse [E(x)=4,200] 32.43% 28.77% 15.79% Risk-averse [E(x)=2,100] 75.68% 69.86% 57.89% Risk-averse [E(x)=50,000] 43.24% 30.14% 21.05% Risk-averse [E(x)=25,000] 86.49% 79.45% 73.68% Risk-averse [E(x)=50 million] 64.86% 52.05% 47.37% Risk-averse [E(x)=25 million] 94.59% 89.04% 78.95%

Ascending Descending 21.43% 3.70% 0.00% 30.43% 21.74% 25.00%

Risk Seeking [E(x)=400.40] 72.97% 84.93% 89.47% Risk Seeking [E(x)=100.80] 27.03% 38.36% 42.11% Risk Seeking [E(x)=8,408.40] 67.57% 71.23% 84.21% Risk Seeking [E(x)=2,116.80] 24.32% 30.14% 42.11% Risk Seeking [E(x)=101,000] 56.76% 69.86% 78.95% Risk Seeking [E(x)=25,200] 13.51% 20.55% 26.32% Risk Seeking [E(x)=101 million] 35.14% 47.95% 52.63% Risk Seeking [E(x)=25.2 million] 5.41% 10.96% 21.05%

Ascending Descending 78.57% 96.30% 100.00% 69.57% 78.26% 75.00%

85.71% 66.67% 63.64%

65.22% 58.70% 50.00%

14.29% 33.33% 36.36%

34.78% 41.30% 50.00%

28.57% 25.93% 0.00%

34.78% 30.43% 37.50%

71.43% 74.07% 100.00%

65.22% 69.57% 62.50%

85.71% 62.96% 63.64%

69.57% 73.91% 50.00%

14.29% 37.04% 36.36%

30.43% 26.09% 50.00%

21.43% 22.22% 0.00%

56.52% 34.78% 50.00%

78.57% 77.78% 100.00%

43.48% 65.22% 50.00%

78.57% 74.07% 63.64%

91.30% 82.61% 87.50%

21.43% 25.93% 36.36%

8.70% 17.39% 12.50%

50.00% 59.26% 36.36%

73.91% 47.83% 62.50%

50.00% 40.74% 63.64%

26.09% 52.17% 37.50%

92.86% 85.19% 63.64%

95.65% 91.30% 100.00%

7.14% 14.81% 36.36%

4.35% 8.70% 0.00%

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Domestic Of Average Wealth [N=146]10

Question 2: Less Wealthy State Wealthy State Question 3: Less Wealthy State ** Wealthy State ** Question 5: Less Wealthy State ** Wealthy State ** Question 7: Less Wealthy State ** Wealthy State ** Question 9: Less Wealthy State ** Wealthy State ** Question 11: Less Wealthy State ** Wealthy State ** Question 13: Less Wealthy State ** Wealthy State ** Question 15: Less Wealthy State ** Wealthy State ** Question 17: Less Wealthy State ** Wealthy State ** ** 1% Significance

Percent Respondents 45.21% 54.79% Risk-averse [E(x)=200] 9.09% 16.25% Risk-averse [E(x)=100] 54.55% 66.25% Risk-averse [E(x)=4,200] 15.15% 17.50% Risk-averse [E(x)=2,100] 75.76% 73.75% Risk-averse [E(x)=50,000] 24.24% 28.75% Risk-averse [E(x)=25,000] 86.36% 86.25% Risk-averse [E(x)=50 million] 60.61% 56.25% Risk-averse [E(x)=25 million] 92.42% 91.25%

Ascending Descending 8.00% 15.79% 9.76% 16.39%

Risk Seeking [E(x)=400.40] 90.91% 83.75% Risk Seeking [E(x)=100.80] 45.45% 33.75% Risk Seeking [E(x)=8,408.40] 84.85% 82.50% Risk Seeking [E(x)=2,116.80] 24.24% 26.25% Risk Seeking [E(x)=101,000] 75.76% 71.25% Risk Seeking [E(x)=25,200] 13.64% 13.75% Risk Seeking [E(x)=101 million] 39.39% 43.75% Risk Seeking [E(x)=25.2 million] 7.58% 8.75%

Ascending Descending 92.00% 84.21% 90.24% 83.61%

76.00% 73.68%

41.46% 63.93%

24.00% 26.32%

58.54% 36.07%

12.00% 10.53%

17.07% 19.67%

88.00% 89.47%

82.93% 80.33%

88.00% 78.95%

68.29% 72.13%

12.00% 21.05%

31.71% 27.87%

16.00% 5.26%

29.27% 36.07%

84.00% 94.74%

70.73% 63.93%

96.00% 78.95%

80.49% 88.52%

4.00% 21.05%

19.51% 11.48%

68.00% 47.37%

56.10% 59.02%

32.00% 52.63%

43.90% 40.98%

92.00% 89.47%

92.68% 91.80%

8.00% 10.53%

7.32% 8.20%

10 States classified as “Less Wealthy” have a 2010 state GDP < US per capita GDP for 2010 ($47,482) http://en.wikipedia.org/wiki/List_of_U.S._states_by_GDP

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International Of Average Wealth [N=73]11

Question 2: Non-OECD Country OECD Country Question 3: Non-OECD Country ** OECD Country ** Question 5: Non-OECD Country ** OECD Country ** Question 7: Non-OECD Country ** OECD Country ** Question 9: Non-OECD Country ** OECD Country ** Question 11: Non-OECD Country ** OECD Country ** Question 13: Non-OECD Country ** OECD Country ** Question 15: Non-OECD Country ** OECD Country ** Question 17: Non-OECD Country ** OECD Country ** ** 1% Significance

Percent Respondents 28.77% 71.23% Risk-averse [E(x)=200] 14.29% 15.38% Risk-averse [E(x)=100] 57.14% 63.46% Risk-averse [E(x)=4,200] 42.86% 23.08% Risk-averse [E(x)=2,100] 57.14% 75.00% Risk-averse [E(x)=50,000] 38.10% 26.92% Risk-averse [E(x)=25,000] 66.67% 84.62% Risk-averse [E(x)=50 million] 47.62% 53.85% Risk-averse [E(x)=25 million] 85.71% 90.38%

Ascending Descending 12.50% 0.00% 15.38% 24.24%

Risk Seeking [E(x)=400.40] 85.71% 80.77% Risk Seeking [E(x)=100.80] 42.86% 32.69% Risk Seeking [E(x)=8,408.40] 57.14% 73.08% Risk Seeking [E(x)=2,116.80] 42.86% 23.08% Risk Seeking [E(x)=101,000] 61.90% 73.08% Risk Seeking [E(x)=25,200] 33.33% 15.38% Risk Seeking [E(x)=101 million] 52.38% 46.15% Risk Seeking [E(x)=25.2 million] 14.29% 9.62%

Ascending Descending 87.50% 100.00% 84.62% 69.70%

62.50% 68.42%

53.85% 60.61%

37.50% 31.58%

46.15% 33.33%

62.50% 10.53%

30.77% 30.30%

37.50% 89.47%

69.23% 63.64%

62.50% 63.16%

53.85% 81.82%

37.50% 36.84%

46.15% 15.15%

37.50% 15.79%

38.46% 33.33%

62.50% 84.21%

61.54% 66.67%

75.00% 73.68%

61.54% 90.91%

25.00% 26.32%

38.46% 9.09%

37.50% 68.42%

53.85% 45.45%

62.50% 31.58%

46.15% 54.55%

100.00% 78.95%

76.92% 96.97%

0.00% 21.05%

23.08% 3.03%

11 http://www.oecd.org/countrieslist/0,3351,en_33873108_33844430_1_1_1_1_1,00.html

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Figure 1. The fourfold utility function consisting of two autonomous twofold Reverse S-shaped utility functions. The shaded area replicates the twofold PT S-shaped value function. S (downside target) denotes an acceptable level of loss while PCS (upside target) denotes a personal consumption level of saturation. Source: Viole and Nawrocki (2011).

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Table 1. Comparison of situation amounts and percentages for Prospect Theory, Allais, and our Survey.

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Table 2. Local utilities of identical amounts for different aggregate subjective wealth levels and various levels of gain seeking appetite (q) according to the gain function from Viole and Nawrocki 2011a. “Less Wealthy” U(x) = f (UPM (q,l,a) – LPM (q,a,x) + U(0)) q=1 q=2

U(50) = 500 – 450 + 500 U(50) = 550 utils U(280) = 500 – 220 + 500 U(280) = 780 utils U(50) = 250,000 – 202,500 + 250,000 U(50) = 297,500 utils U(280) = 250,000 – 48,400 + 250,000 U(280) = 451,600 utils

q=3

U(50) = 125,000,000 – 91,125,000 + 125,000,000

**U(50) = 158,875,000 utils
**

U(280) = 125,000,000 – 10,648,000 + 125,000,000

U(280) = 239,352,000 utils

Increase: 41.8%

51.8%

50.7%

**“Of Average Wealth” U(x) = f (UPM (q,l,a) – LPM (q,a,x) + U(0)) q=1 q=2
**

U(50) = 300 – 250 + 300 U(50) = 350 utils U(280) = 300 – 20 + 300 U(280) = 580 utils U(50) = 90,000 – 62,500 + 90,000 U(50) = 117,500 utils U(280) = 90,000 – 400 + 90,000 U(280) = 179,600 utils

q=3

U(50) = 27,000,000 – 15,625,000 + 27,000,000

U(50) = 38,375,000 utils U(280) = 27,000,000 – 8,000 + 27,000,000 U(50) = 53,992,000 utils

Increase: 65.7%

52.8%

40.7%

**“Wealthy” U(x) = f (UPM (q,l,a) – LPM (q,a,x) + U(0)) q=1 q=2
**

U(50) = 100 – 50 + 100 U(50) = 150 utils U(50) = 10,000 – 2,500 + 10,000 U(50) = 17,500 utils

q=3

U(50) = 1,000,000 – 150,000 + 1,000,000 U(50) = 1,850,000 utils

U(x) = f (UPM (q,l,x) + UPM (q,a,x) + U(0))

U(280) = 100 + 180 + 100 U(280) = 480 utils U(280) = 10,000 + 32,400 + 10,000 U(280) = 52,400 utils

U(280) = 1,000,000 + 5,832,000 + 1,000,000

U(280) = 7,832,000 utils

Increase: 220.0%

199.4%

323.4%

35 | P a g e

**Table 3. Percentage of amounts selected as influencing the decision for each subjective wealth group.
**

Question Amount “Less Wealthy” “Of Average Wealth” “Wealthy” 4 200 20.8 6 200 32.0 8 4,200 30.9 10 4,200 43.7

0 22.3

1,120 56.9

0 34.7

1,120 33.3

0 22.0

23,520 47.1

0 38.0

23,520 18.3

15.8

16.8

67.4

31.4

32.6

36.0

17.4

23.3

59.3

35.5

41.0

23.5

11.4

12.9

75.7

26.4

27.8

45.8

12.9

40.0

47.1

18.1

37.5

44.4

Question Amount “Less Wealthy” “Of Average Wealth” “Wealthy”

0 30.9

12 50,000 38.2

280,000 30.9

0 42.6

14 50,000 50.0

280,000 7.4

0 34.4

16 50m 45.3

280m 20.3

0 43.8

18 50m 51.6

280m 4.6

21.0

27.5

51.5

36.9

46.9

16.2

25.2

50.3

24.5

41.5

49.0

9.5

13.0

33.3

53.7

21.7

49.3

29.0

10.3

55.9

33.8

18.5

60.0

21.5

36 | P a g e

Figure 2. % of Risk-Averse selections for the “Allais” question set.

37 | P a g e

Figure 3. % of Risk-Averse selections for the “Prospect Theory” question set.

38 | P a g e

Figure 4. Optimal selections based on highest nominal outcome and subjective wealth groups’ cumulative average score.

39 | P a g e

PCS Level

“Of Average Wealth” “Less Wealthy”

“Wealthy”

Aggregate Wealth Figure 5. Aggregate total subjective wealth positions relative to the Personal Consumption Saturation (PCS) level.

40 | P a g e

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