Prospect Theory

James Ming Chen
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James Ming Chen: Michigan State University

Chapter Chapter 8 in Finance and the Behavioral Prospect, 2016, pp 181-212 from Palgrave Macmillan

Abstract: Abstract This chapter explores prospect theory’s depiction of the impact of fear and greed on financial markets. Prospect theory posits that the human evaluation of uncertain gains and losses departs from a purely rational account of expected utility in three crucial ways. First, humans pay heed to a reference point, whether it is the price paid for a security or a target rate of return. Second, humans hate losing more than they like winning. Third, humans grow less sensitive to the magnitude of changes in welfare as gains or losses increase. Critically, diminished sensitivity applies to gains as well as losses. The resulting “fourfold pattern” of human responses to uncertainty provides a far more complete and persuasive account of risk-averse as well as risk-seeking behavior.

Keywords: Weighting Function; Risk Aversion; Lognormal Distribution; Supra Note; Prospect Theory (search for similar items in EconPapers)
Date: 2016
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Persistent link: https://EconPapers.repec.org/RePEc:pal:qpochp:978-3-319-32711-2_8

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DOI: 10.1007/978-3-319-32711-2_8

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