Prospect Theory in the Heterogeneous Agent Model

Jan Polach and Jiri Kukacka

No 2016/14, Working Papers IES from Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies

Abstract: Using the Heterogeneous Agent Model framework, we incorporate an extension based on Prospect Theory into a popular agent-based asset pricing model. The extension covers the phenomenon of loss aversion manifested in risk aversion and asymmetric treatment of gains and losses. Using Monte Carlo methods, we investigate behavior and statistical properties of the extended model and assess its relevance with respect to financial data and stylized facts. We show that the Prospect Theory extension keeps the essential underlying mechanics of the model intact, however, that it changes the model dynamics considerably. Stability of the model increases but the occurrence of the fundamental strategy is more extreme. Moreover, the extension shifts the model closer to the behavior of real-world stock markets.

Keywords: Heterogeneous Agent Model; Prospect Theory; Behavioral Finance; Stylized facts (search for similar items in EconPapers)
JEL-codes: C1 C61 D84 G12 (search for similar items in EconPapers)
Pages: 32pages
Date: 2016-07, Revised 2016-07
New Economics Papers: this item is included in nep-hme, nep-ore and nep-upt
References: Add references at CitEc
Citations: View citations in EconPapers (3)

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Journal Article: Prospect Theory in the Heterogeneous Agent Model (2019)
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