Does Prospect Theory Explain the Disposition Effect?
AbstractThe disposition effect is the observation that investors hold winning stocks too long and sell losing stocks too early. A standard explanation of the disposition effect refers to prospect theory and in particular to the asymmetric risk aversion according to which investors are risk averse when faced with gains and risk-seeking when faced with losses. We show that for reasonable parameter values the disposition effect can however not be explained by prospect theory as proposed by Kahneman and Tversky. The reason is that those investors who sell winning stocks and hold loosing assets would in the first place not have invested in stocks. That is to say the standard prospect theory argument is sound ex-post, assuming that the investment has taken place, but not ex-ante, requiring that the investment is made in the first place.
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Bibliographic InfoPaper provided by Department of Business and Management Science, Norwegian School of Economics in its series Discussion Papers with number 2005/18.
Length: 37 pages
Date of creation: 22 Dec 2005
Date of revision:
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Disposition effect; prospect theory; portfolio choice;
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-10-28 (All new papers)
- NEP-CBE-2006-10-28 (Cognitive & Behavioural Economics)
- NEP-FIN-2006-10-28 (Finance)
- NEP-UPT-2006-10-28 (Utility Models & Prospect Theory)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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