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.

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.

dandman

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

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

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..