A Behavioral Finance Q (V2,P48,Q5) understand, behavioral, difference, question, between

stockjaguar

I have a hard time to understand the difference between behavioral portfolio theory from prospect theory. I thought they were the same thing or closely related. Can you explain the answer of that EOC question(Q5) in more details? Thanks.

Fdez

I see why prospect theory is not the correct answer to this question, but I am having trouble grasping why it is BPT. From what I can see, BPT is striclty about constructing a portfolio in layers (risk free assets, semi-risky assets, and very risky assets to achieve goals); I don’t see anything about risk or loss aversion. Am I missing something?

NakedPuts

I am thinking that the sell discipline is the final outcome, are you saying that the discipline is one of the outcomes of the 6 steps of editing?  
Any process involving steps would have an outcome to each step towards the final outcome. Isn’t Prospect Theory just a process of wittling down choices to come a perceived optimal choice by applying the outcomes of each step to the next appropriate editing phase?

dkishore1

how do you say the following, FinNinja?
Quote:
The way I have understood Prospect Theory is that it defines the process of making decisions and not the outcome
End Quote:
the process of making decisions and the outcome are kind of intertwined there.
The 6 steps of editing - Codification, Combination,Segregation, Cancellation, Simplification, and Detection of dominance - esp. the last three steps - would be based on the outcomes of the first three steps and would decide the final outcome, wouldn’t it?

JPSem

The way I have understood Prospect Theory is that it defines the process of making decisions and not the outcome. I don’t believe that saying whether someone would or would not choose this sell discipline can be based on Prospect Theory alone without regard to the process the individual takes to arrive at this decision. This is why, as Prospect Theory states, people can come to different conclusions regarding the same decision.

EastCoastJ

imagine it this way…in the area of losses the guy is a degenerate gambler  putting coins in the slot machine despite having lost loads of money already , believing in that big payoff someday…in the area of gains the guy is like your grandma, if she finds 2$ on the floor she will be happy for a year…
The question would have been consistent with prospect theory if the client :
[a] Sold the 15 % gain position (because he is risk averse over gains) = grandma
[b] Continue investing in the  25% loss position (because he is risk loving over losses) = Gambler.
…i think,

Flok

the prospect theory guy would not sell if he has a loss … is what you both are saying … so that is inconsistent with that aspect. He would NOT have this sell discipline if he was a Prospect theorist.
(and yes, I realized I was wrong … corrected / edited my previous error post)

thecfawannabe

I agree with Alladin, and see why the answer would not be prospect theory as long as they stick to their sell discipline.

yodacaia

The loss averse investor using prospect theory to evaluate prospects would:
hold on to losing positions of -25% as he is more risk seeking in the area of losses. He would ‘gamble’ his way out of a loss position rather than close it…since the client from Q5 will sell the losing position, this does not corroborate prospect theory….i think…
under prospect theory an individual is risk averse over gains/risk loving over losses, that means if he makes a gain, he is more likely to realise that gain,and if he makes a loss he would be more risky and continue to gamble , since he is loosing anyways…

sdada

it is not .