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Evaluation with Dynamic Reference: Sustainable Investment

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  • Leon Vinokur

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    (Queen Mary, University of London)

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    Abstract

    The 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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    File URL: http://www.econ.qmul.ac.uk/papers/doc/wp651.pdf
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    Bibliographic Info

    Paper provided by Queen Mary, University of London, School of Economics and Finance in its series Working Papers with number 651.

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    Date of creation: Oct 2009
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    Handle: RePEc:qmw:qmwecw:wp651

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    Keywords: Prospect theory; Dynamic reference; Sustainable development;

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