 Prospect theory and trading patternsJing Yao and Duan Li Journal of Banking & Finance, 2013, vol. 37, issue 8, 2793-2805 Abstract: Reference dependence, loss aversion, and risk seeking for losses together comprise the preference-based component of prospect theory that sets its value function apart from the standard risk-aversion model. Using an elasticity analysis, we show that this distinctive preference component serves to underpin negative-feedback trading propensities, but cannot manifest itself in behavior directly or holistically at the individual-choice level. We then propose and demonstrate that the market interaction between prospect-theory investors and regular CRRA investors allows this preference component to dominate in equilibrium behavior and hence helps to reestablish the intuitive link between prospect-theory preferences and negative-feedback trading patterns. In the model, the interaction also reconciles the contrarian behavior of prospect-theory investors with asymmetric volatility and short-term return reversal. The results suggest that prospect-theory preferences can lead investors to behave endogenously as contrarian noise traders in the market interaction process. Keywords: Prospect theory; Negative-feedback trading; Price elasticity of demand; Contrarian behavior; Disposition effect; Noise trading (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:37:y:2013:i:8:p:2793-2805 DOI: 10.1016/j.jbankfin.2013.04.001 Access Statistics for this article Journal of Banking & Finance is currently edited by Ike Mathur More articles in Journal of Banking & Finance from Elsevier |
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