Great expectations: Prospect theory with a consistent reference point

I apply a prospect theory model of risk preferences with an endogenously determined reference point to propose an alternative objective of maximizing expected outcome rather than maximizing expected utility. I show that an agent can always form a consistent expected outcome for any binary gamble and derive a parametric formula, which can then be used to examine the effects of loss aversion, risk aversion, and probability weighting on behavior. To illustrate the applicability of the results, I use this model to consider the incentives of an agent purchasing insurance against the possibility of a loss and show that it is optimal for him to either purchase full insurance or purchase no insurance. JEL Classification D03, D81, D84