Market equilibrium with heterogeneous behavioural and classical investors' preferences
AbstractStarting from the theory of portfolio selection under Cumulative Prospect Theory (CPT) in a one period model, we firstly present some remarks connected with the violation of the so-called loss aversion in the case of power utility functions. The main contribution of this paper comes from the analysis of two equilibrium models. In the first one, an Expected Utility (EU) maximizer, a CPT agent and an accommodating market maker are allowed to interact. We show that there can be equilibria with null, positive or total risky investment by the CPT trader. Our results are then compared to an analogous model with two EU maximizers. On the contrary, the second financial market is populated by a sufficiently large number of EU agents and CPT agents, each of them being price maker and endowed with possibly heterogeneous preferences, these two facts being new to the literature. This time EU traders fully invest in stocks whereas CPT traders stay out of the risky market. For both models, equilibrium existence and robustness is shown using analytical and numerical methods.
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Bibliographic InfoPaper provided by Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa in its series Working Papers - Mathematical Economics with number 2011-09.
Length: 39 pages
Date of creation: Apr 2011
Date of revision:
Cumulative Prospect Theory; equilibrium models; loss aversion; heterogeneous preferences; portfolio optimisation; volatility impact;
Find related papers by JEL classification:
- C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
- D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-10-01 (All new papers)
- NEP-CMP-2011-10-01 (Computational Economics)
- NEP-UPT-2011-10-01 (Utility Models & Prospect Theory)
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