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Probability weighting and L-moments

Blavatskyy, P. (2016) Probability weighting and L-moments. European Journal of Operational Research, 255 (1). pp. 103-109.

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Several popular generalizations of expected utility theory - cumulative prospect theory, rank-dependent utility and Yaari's dual model - allow for non-linear transformation of (de-)cumulative probabilities. This paper shows an unexpected connection between probability weighting and the statistical theory of L-moments. Specifically, cubic probability weighting results in a linear tradeoff between the expected value (the first L-moment), Gini (1912) mean difference statistic (the second L-moment, also known as L-scale) and the third L-moment (measuring skewness). Inverse S-shaped probability weighting function crossing the 45° line at a probability ≤0.5 reflects an aversion to the dispersion of outcomes and an attraction to positively skewed distributions.

Publication Type: Journal Article
Murdoch Affiliation: School Of Business and Governance
Publisher: Elsevier BV
Copyright: © 2016 Elsevier B.V.
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