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Evaluation with Dynamic Reference: Sustainable Investment

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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.

Suggested Citation

  • Leon Vinokur, 2009. "Evaluation with Dynamic Reference: Sustainable Investment," Working Papers 651, Queen Mary University of London, School of Economics and Finance.
  • Handle: RePEc:qmw:qmwecw:wp651
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    Keywords

    Prospect theory; Dynamic reference; Sustainable development;

    JEL classification:

    • D46 - Microeconomics - - Market Structure, Pricing, and Design - - - 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

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