Discussion Papers, Department of Finance and Management Science, Norwegian School of Economics (NHH)
No 2005/19:
Making Prospect Theory Fit for Finance
Enrico De Giorgi ()
and Thorsten Hens ()
Abstract: This paper gives a survey over a common aspect of prospect
theory that occurred to be of importance in a series of recent papers
developed by Enrico De Giorgi, Thorsten Hens, Janos Mayer, Haim Levy,
Thierry Post, Marc Oliver Rieger and Mei Wang. The common aspect of these
papers is that the value function of the prospect theory of Kahneman and
Tversky (1979) and similarly that of Tversky and Kahneman (1992) has to be
re-modelled if one wants to apply it to portfolio selection. Instead of the
piecewise power value function, a piecewise negative exponential function
should be used. This functional form is still compatible with laboratory
experiments but it has the following advantages over and above Kahneman and
Tversky`s piecewise power function:
1. The Bernoulli Paradox does not
arise for lotteries with finite expected value.
2. No infinite
leverage/robustness problem arises.
3. CAPM-equilibria with
heterogeneous investors and prospect utility do exist.
4. It is able to
simultaneously resolve the following asset pricing puzzles: the equity
premium, the value and the size puzzle.
Keywords: Prospect theory; portfolio selection; (follow links to similar papers)
JEL-Codes: G00; (follow links to similar papers)
18 pages, December 22, 2005
Before downloading any of the electronic versions below
you should read our statement on
copyright.
Download GhostScript
for viewing Postscript files and the
Acrobat Reader for viewing and printing pdf files.
Full text versions of the paper:
1905.pdf 
Download Statistics
Questions (including download problems) about the papers in this series should be directed to Stein Fossen ()
Report other problems with accessing this service to Sune Karlsson ()
or Helena Lundin ().
Programing by
Design by Joachim Ekebom
