Financial market equilibria with cumulative prospect theory
AbstractThe paper first shows that financial market equilibria need not to exist if agents possess cumulative prospect theory preferences with piecewise-power value functions. This is due to the boundary behavior of the cumulative prospect theory value function, which might cause an infinite short-selling problem. But even when a non-negativity constraint on final wealth is added, non-existence can occur due to the non-convexity of CPT preferences, which might cause discontinuities in the agents' demand functions. This latter observation also implies that concavification arguments which has been used in portfolio allocation problems with CPT preferences do not apply to our general equilibrium setting with finite many agents. Existence of equilibria is established when non-negativity constraints on final wealth are imposed and there is a continuum of agents in the market. However, if the original prospect theory is used instead of cumulative prospect theory, then other discontinuity problems can cause non-existence of market equilibria even in this case.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of Mathematical Economics.
Volume (Year): 46 (2010)
Issue (Month): 5 (September)
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Web page: http://www.elsevier.com/locate/jmateco
Cumulative prospect theory Prospect theory General equilibrium model Non-convex preferences Continuum of agents;
Other versions of this item:
- Enrico De Giorgi & Thorsten Hens & Marc Oliver Rieger, 2007. "Financial Market Equilibria With Cumulative Prospect Therory," Swiss Finance Institute Research Paper Series 07-21, Swiss Finance Institute, revised Aug 2007.
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
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