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

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

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.

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Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 33 (2009)
Issue (Month): 7 (July)
Pages: 1221-1229

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Handle: RePEc:eee:jbfina:v:33:y:2009:i:7:p:1221-1229
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  1. Martijn Cremers & Joost Driessen & Pascal Maenhout & David Weinbaum, 2004. "Individual Stock-Option Prices and Credit Spreads," Yale School of Management Working Papers amz2391, Yale School of Management, revised 01 Jan 2005.
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  12. Edwards, Kimberley D., 1996. "Prospect theory: A literature review," International Review of Financial Analysis, Elsevier, vol. 5(1), pages 19-38.
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  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.
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