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.

prashantsahni

key difference seems to be the way gains / losses are treated in the two.
Here - both in case of a 15% gain and a 25% loss - the security is being SOLD.
For Prospect theory - with a 15% gain - you would take on more risk - and buy more, while for the loss case - you would sell it …
this is my understanding at the present moment..

dkishore1

This one puzzled me too . Naturally I chose prospect theory because of the skew between treating gains and losses.
I rationalized ( uselessly , because I have no real answer) that it is because :
1. It is not a knee jerk reaction to a loss ( prospect theory stresses on loss aversion ) but a planned strategy that yet brings in a behavioral bias into focus.
But cpk may  have hit on the right idea . Loss aversion is more pronounced in Prospect theory and you would delay selling to try and see if the stock recovers. You would also take gains early not to let the gains  disappear. This person is having a more disciplined approach, which is nevertheless skewed in its probabilities

dandman

Loss aversion investor won’t set selling strategy of gain 15% and loss 25%.  So, prospect theory is not correct.

spartanag07

not sure where you are getting at Fin - answer is BPT - not Prospect Theory.
The reason is - he is SELLING when there is a 15% gain – a Loss Averse person would end up buying the security when he sees the gain.

YAhmed

I thought the answer was prospect theory, I don’t have the book so I can’t look up their justification. However, I still don’t see how this has to do with layering your portfolio. Also, Loss averse investors tend to hold on to losers longer than justified and sell winners earlier than justified AND hold riskier portfolios as a result. A loss averse person is not necessarily a risk averse person.
I will check the guideline answer on this when I have the book with me, but I think what I’ve said here is correct. Let me know if it is not.

sdada

it is not .

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…

thecfawannabe

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

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)