Evaluation with Dynamic Reference: Sustainable Investment
AbstractThe Prospect Theory proposes to assess outcomes relative to a reference point (or benchmark). Although the literature recognises the relevance of dynamic benchmarks, most of the applications of Prospect Theory employ static reference points (or a status quo). This paper aims to develop a Prospect Theory framework for investment under uncertainty subject to a dynamic reference point, within the context of environmental policy making, where the distinction between a dynamic and a static frameworks is crucial. I evince that, in contrast to the static framework, in a dynamic framework the investor measures not only the absolute but also the relative risk premium (Sharpe ratio) of the investment opportunity, incorporating the risks and returns of a reference portfolio. I propose that there exists a relation between static and dynamic frameworks. Using the dynamic framework, I argue that in the environmental context international co-operation is the key to a successful environmental policy.
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Bibliographic InfoPaper provided by Queen Mary, University of London, School of Economics and Finance in its series Working Papers with number 651.
Date of creation: Oct 2009
Date of revision:
Prospect theory; Dynamic reference; Sustainable development;
Find related papers by JEL classification:
- D46 - Microeconomics - - Market Structure and Pricing - - - Value Theory
- G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
- Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-10-24 (All new papers)
- NEP-RES-2009-10-24 (Resource Economics)
- NEP-UPT-2009-10-24 (Utility Models & Prospect Theory)
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