INTBUS 6 Lecture Notes - Lecture 20: Prospect Theory, Loss Aversion, Utility
5 Oct 2020
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Date of the session: 27th of november 2017. Prospect theory in the wild: evidence from the field. In expected utility, gambles that yield risky outcomes xi with probabilities pi are valued according to pi u(xi), where u(x) is the utility of outcome x. In prospect theory they are valued by (pi)v(xi r), where (p) is a function that weights probabilities nonlinearly, overweighting probabilities below. Stocks or equities tend to have more variable annual price changes (or returns ) than bonds do. They called this the disposition effect: the disposition effect is anomalous because the purchase price of a stock should not matter much for whether you decided to sell it. If you think the stock will rise, you should keep it; if you think it will fall, you should sell it. In addition, tax laws encourage people to sell losers rather than winners because such sales generate losses that can be used to reduce the taxes owed on capital gains.
