Prospect theory in a dynamic game: Theory and evidence from online pay-per-bid auctions

Abstract

Abundant evidence exists that expected utility theory does not adequately describe decision making under risk. Although prospect theory is a popular alternative, it is rarely applied in strategic situations in which risk arises through individual interactions. This study fills this research gap by incorporating prospect theory preferences into a dynamic game theoretic model. Using a large field data set from multiple online pay-per-bid auction sites, the authors empirically show that their proposed model with prospect theory preferences makes a better out-of-sample prediction than a corresponding expected utility model. Prospect theory also provides a unified explanation for two behavioral anomalies: average auctioneer revenues above current retail prices and the sunk cost fallacy. The empirical results indicate that bidders are loss averse and overweight small probabilities, such that the expected revenue of the auction exceeds the current retail price by 25.46%. The authors illustrate and empirically confirm a managerial implication for how an auctioneer can increase revenue by changing the details of the auction design.

Location and Strategies in Stackelberg Security Games with Risk Aversion

“…The first order stochastic dominance constraint D(x) ⪰ (1) D( x) can thus be represented by the |V| constraints in (7) which are of type (3) with Ξ = 1 − v≤ v pv( x), ξv = 1 for every v ∈ V, and v = v + 1.…”

“…Where π(•) and V (•) are perturbation functions with specific properties that model how players perceive both payoffs and the likelihood of occurrence. Prospect theory has contributed in economics [32], politics [23], online auctions [7], and security [37] applications.…”

The Tripartite Regulation Game of Carbon Financial Products Based on the Prospect Theory

“…In addition, the subjectivity of players causes the differences between expected and real actions. The prospect theory is an effective descriptive theory for the behavior of players and also adequately describes situations in which players face exogenous risk (Brunner et al, 2019;Vahid-Pakdel et al, 2019). This study fills this research gap by incorporating the prospect theory into a dynamic game model with heterogeneous participants.…”

A Construction Schedule Robustness Measure Based on Improved Prospect Theory and the Copula-CRITIC Method

“…It can be concluded that human judgments have individual preferences. Prospect theory has established a successful model to simulate the psychological and behavioral characteristics of human beings, which has been widely applied in the field of engineering [27][28][29], economics [30][31][32], computer science [33][34][35], and so on. This provides a convincing explanation of the fact that the results of subjective empowerment do not conform to reality.…”