IDEAS home Printed from https://ideas.repec.org/a/eee/jbfina/v33y2009i7p1221-1229.html
   My bibliography  Save this article

Decision-making under uncertainty - A field study of cumulative prospect theory

Author

Listed:
  • Gurevich, Gregory
  • Kliger, Doron
  • Levy, Ori

Abstract

The presented research tests cumulative prospect theory (CPT, [Kahneman, D., Tversky, A., 1979. Prospect theory: An analysis of decision under risk. Econometrica 47, 263-291; Tversky, A., Kahneman, D., 1981. The framing of decisions and the psychology of choice. Science 211, 453-480]) in the financial market, using US stock option data. Option prices possess information about actual investors' preferences in such a way that an exploitation of conventional option analysis, along with theoretical relationships, makes it possible to elicit investor preferences. The option data in this study serve for estimating the two essential elements of the CPT, namely, the value function and the probability weighting function. The main part of the work focuses on the functions' simultaneous estimation under CPT original parametric specification. The shape of the estimated functions is found to be in line with theory. Comparing to results of laboratory experiments, the estimated functions are closer to linearity and loss aversion is less pronounced.

Suggested Citation

  • Gurevich, Gregory & Kliger, Doron & Levy, Ori, 2009. "Decision-making under uncertainty - A field study of cumulative prospect theory," Journal of Banking & Finance, Elsevier, vol. 33(7), pages 1221-1229, July.
    • Handle: RePEc:eee:jbfina:v:33:y:2009:i:7:p:1221-1229
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0378-4266(09)00004-1
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Ait-Sahalia, Yacine & Lo, Andrew W., 2000. "Nonparametric risk management and implied risk aversion," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 9-51.
    2. Breeden, Douglas T & Litzenberger, Robert H, 1978. "Prices of State-contingent Claims Implicit in Option Prices," The Journal of Business, University of Chicago Press, vol. 51(4), pages 621-651, October.
    3. Venezia, Itzhak & Shapira, Zur, 2007. "On the behavioral differences between professional and amateur investors after the weekend," Journal of Banking & Finance, Elsevier, vol. 31(5), pages 1417-1426, May.
    4. Leland, Hayne E, 1980. " Who Should Buy Portfolio Insurance?," Journal of Finance, American Finance Association, vol. 35(2), pages 581-594, May.
    5. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-291, March.
    6. George Wu & Richard Gonzalez, 1996. "Curvature of the Probability Weighting Function," Management Science, INFORMS, vol. 42(12), pages 1676-1690, December.
    7. Cremers, Martijn & Driessen, Joost & Maenhout, Pascal & Weinbaum, David, 2008. "Individual stock-option prices and credit spreads," Journal of Banking & Finance, Elsevier, vol. 32(12), pages 2706-2715, December.
    8. Tversky, Amos & Kahneman, Daniel, 1992. "Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
    9. Jackwerth, Jens Carsten, 2000. "Recovering Risk Aversion from Option Prices and Realized Returns," Review of Financial Studies, Society for Financial Studies, vol. 13(2), pages 433-451.
    10. Edwards, Kimberley D., 1996. "Prospect theory: A literature review," International Review of Financial Analysis, Elsevier, vol. 5(1), pages 19-38.
    11. Han Bleichrodt & Jose Luis Pinto, 2000. "A Parameter-Free Elicitation of the Probability Weighting Function in Medical Decision Analysis," Management Science, INFORMS, vol. 46(11), pages 1485-1496, November.
    12. Gurdip Bakshi & Nikunj Kapadia & Dilip Madan, 2003. "Stock Return Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options," Review of Financial Studies, Society for Financial Studies, vol. 16(1), pages 101-143.
    13. Klaus Abbink & Bettina Rockenbach, 2006. "Option pricing by students and professional traders: a behavioural investigation," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 27(6), pages 497-510.
    14. Hibbert, Ann Marie & Daigler, Robert T. & Dupoyet, Brice, 2008. "A behavioral explanation for the negative asymmetric return-volatility relation," Journal of Banking & Finance, Elsevier, vol. 32(10), pages 2254-2266, October.
    15. Kroll, Yoram & Levy, Haim & Rapoport, Amnon, 1988. "Experimental Tests of the Separation Theorem and the Capital Asset Pricing Model," American Economic Review, American Economic Association, vol. 78(3), pages 500-519, June.
    16. Cox, John C. & Ross, Stephen A., 1976. "The valuation of options for alternative stochastic processes," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 145-166.
    17. Kliger, Doron & Kudryavtsev, Andrey, 2008. "Reference point formation by market investors," Journal of Banking & Finance, Elsevier, vol. 32(9), pages 1782-1794, September.
    18. Constantinides, George M, 1982. "Intertemporal Asset Pricing with Heterogeneous Consumers and without Demand Aggregation," The Journal of Business, University of Chicago Press, vol. 55(2), pages 253-267, April.
    19. Mohammed Abdellaoui, 2000. "Parameter-Free Elicitation of Utility and Probability Weighting Functions," Management Science, INFORMS, vol. 46(11), pages 1497-1512, November.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Fortin, Ines & Hlouskova, Jaroslava, 2011. "Optimal asset allocation under linear loss aversion," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 2974-2990, November.
    2. Arisoy, Yakup Eser, 2010. "Volatility risk and the value premium: Evidence from the French stock market," Journal of Banking & Finance, Elsevier, vol. 34(5), pages 975-983, May.
    3. Luis A.G. Coelho, 2014. "Portfolio Selection Optimization under Cumulative Prospect Theory – a parameter sensibility analysis," CEFAGE-UE Working Papers 2014_06, University of Evora, CEFAGE-UE (Portugal).
    4. Daniel Cavagnaro & Mark Pitt & Richard Gonzalez & Jay Myung, 2013. "Discriminating among probability weighting functions using adaptive design optimization," Journal of Risk and Uncertainty, Springer, vol. 47(3), pages 255-289, December.
    5. Mohammed Abdellaoui & Han Bleichrodt & Hilda Kammoun, 2013. "Do financial professionals behave according to prospect theory? An experimental study," Theory and Decision, Springer, vol. 74(3), pages 411-429, March.
    6. Hwang, Soosung & Satchell, Steve E., 2010. "How loss averse are investors in financial markets?," Journal of Banking & Finance, Elsevier, vol. 34(10), pages 2425-2438, October.
    7. Krčál, Ondřej & Kvasnička, Michal & Staněk, Rostislav, 2016. "External validity of prospect theory: The evidence from soccer betting," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 65(C), pages 121-127.
    8. Dichtl, Hubert & Drobetz, Wolfgang, 2011. "Portfolio insurance and prospect theory investors: Popularity and optimal design of capital protected financial products," Journal of Banking & Finance, Elsevier, vol. 35(7), pages 1683-1697, July.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jbfina:v:33:y:2009:i:7:p:1221-1229. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu). General contact details of provider: http://www.elsevier.com/locate/jbf .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.