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An Empirical Test of Gain-Loss Separability in Prospect Theory

Center for Decision Research, Graduate School of Business, University of Chicago, Chicago, Illinois 60637
Stern School of Business, New York University, New York, New York 10012
wu{at}chicagogsb.edu
amarkle{at}stern.nyu.edu

We investigate a basic premise of prospect theory: that the valuation of gains and losses is separable. In prospect theory, gain-loss separability implies that a mixed gamble is valued by summing the valuations of the gain and loss portions of that gamble. Two experimental studies demonstrate a systematic violation of the double-matching axiom, an axiom that is necessary for gain-loss separability. We document a reversal between preferences for mixed gambles and the associated gain and loss gambles—mixed gamble A is preferred to mixed gamble B, but the gain and loss portions of B are preferred to the gain and loss portions of A. The observed choice patterns are consistent with a process in which individuals are less sensitive to probability differences when choosing among mixed gambles than when choosing among either gain or loss gambles.

Key Words: risky choice; prospect theory; mixed gambles; double matching; probability weighting function
History: Received: September 5, 2007;