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Decision-making under uncertainty - A field study of cumulative prospect theory

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Author Info

  • Gurevich, Gregory
  • Kliger, Doron
  • Levy, Ori

Abstract

The presented research tests cumulative prospect theory (CPT, [Kahneman, D., Tversky, A., 1979. Prospect theory: An analysis of decision under risk. Econometrica 47, 263-291; Tversky, A., Kahneman, D., 1981. The framing of decisions and the psychology of choice. Science 211, 453-480]) in the financial market, using US stock option data. Option prices possess information about actual investors' preferences in such a way that an exploitation of conventional option analysis, along with theoretical relationships, makes it possible to elicit investor preferences. The option data in this study serve for estimating the two essential elements of the CPT, namely, the value function and the probability weighting function. The main part of the work focuses on the functions' simultaneous estimation under CPT original parametric specification. The shape of the estimated functions is found to be in line with theory. Comparing to results of laboratory experiments, the estimated functions are closer to linearity and loss aversion is less pronounced.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 33 (2009)
Issue (Month): 7 (July)
Pages: 1221-1229

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Handle: RePEc:eee:jbfina:v:33:y:2009:i:7:p:1221-1229

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Related research

Keywords: Cumulative prospect theory Value function Probability weighting function Loss aversion;

References

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  1. Ait-Sahalia, Yacine & Lo, Andrew W., 2000. "Nonparametric risk management and implied risk aversion," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 9-51.
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  16. Kliger, Doron & Kudryavtsev, Andrey, 2008. "Reference point formation by market investors," Journal of Banking & Finance, Elsevier, vol. 32(9), pages 1782-1794, September.
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Cited by:
  1. Arisoy, Yakup Eser, 2010. "Volatility risk and the value premium: Evidence from the French stock market," Journal of Banking & Finance, Elsevier, vol. 34(5), pages 975-983, May.
  2. Hwang, Soosung & Satchell, Steve E., 2010. "How loss averse are investors in financial markets?," Journal of Banking & Finance, Elsevier, vol. 34(10), pages 2425-2438, October.

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