A Detailed Prospect Theory Explanation of the Disposition Effect

Dacey, Raymond; Zielonka, Piotr

doi:10.1080/15427560801897758

Cited by 43 publications

(26 citation statements)

References 16 publications

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“…Given our data, we find a weak but statistically significant positive correlation between α and γ and between λ and γ. 35 A statistically significant negative relationship seems to exist between α and λ, which is not only in line with Vlcek and Hens (2011), but also in accordance with other theoretical studies (Kaustia (2004b), Kaustia (2010), Dacey and Zielonka (2008) and Barberis and Xiong (2009).…”

Section: Parameter Estimatessupporting

confidence: 76%

“…With respect to the overall picture on Prospect Theory, the interdependence between α, λ and γ has been discussed in Vlcek and Hens (2011), but is also debated in theoretical studies such as Kaustia (2004b), Polkovnichenko (2005), Dacey and Zielonka (2008), Kaustia (2010), Li and Yang (2009) and Barberis and Xiong (2009). In addition, from an econometric point of view, significant correlation among the estimators may point towards multicollinearity issues, which affects the quality of our estimators as unbiasedness of estimators only holds asymptotically (Gonzalez and Wu (1999b)).…”

Section: Parameter Estimatesmentioning

confidence: 99%

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Taming Models of Prospect Theory in the Wild? Estimation of Vlcek and Hens (2011)

2016

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Abstract. Shortcomings revealed by experimental and theoretical researchers such as Allais (1953), Rabin (2000) and Rabin and Thaler (2001) that put the classical expected utility paradigm von Neumann and Morgenstern (1947) into question, led to the proposition of alternative and generalized utility functions, that intend to improve descriptive accuracy. The perhaps best known among those alternative preference theories, that has attracted much popularity among economists, is the so called Prospect Theory by Kahneman and Tversky (1979) and Tversky and Kahneman (1992). Its distinctive features, governed by its set of risk parameters such as risk sensitivity, loss aversion and decision weights, stimulated a series of economic and financial models that build on the previously estimated parameter values by Tversky and Kahneman (1992) to analyze and explain various empirical phenomena for which expected utility doesn't seem to offer a satisfying rationale. In this paper, after providing a brief overview of the relevant literature, we take a closer look at one of those papers, the trading model of Vlcek and Hens (2011) and analyze its implications on Prospect Theory parameters using an adopted maximum likelihood approach for a dataset of 656 individual investors from a large German discount brokerage firm. We find evidence that investors in our dataset are moderately averse to large losses and display high risk sensitivity, supporting the main assumptions of Prospect Theory.

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Section: Parameter Estimatessupporting

confidence: 76%

Section: Parameter Estimatesmentioning

confidence: 99%

Taming Models of Prospect Theory in the Wild? Estimation of Vlcek and Hens (2011)

2016

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“…The concepts of loss aversion and asymmetric value function are derived and termed as prospect theory. A long line of similar studies has followed (Thaler and Johnson, 1990;Benartzi and Thaler, 1995;Thaler et al, 1997;Gneezy and Potters, 1997;Barberis et al, 2001;Dacey and Zielonka, 2008;Hens and Vlcek, 2011). This article is a continual effort to test the investor rationality in a regulatory context in which investors are incentivized and better positioned to overcome the bounded rationality, biases, and/or other market imperfections such as information asymmetry (Brunnermeier, 2005).…”

Section: Introductionmentioning

confidence: 99%

Can a securities law improve investor rationality in processing earnings information?

Kwag¹

2014

Journal of the Korean Data and Information Science Society

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In this paper, I propose a general hypothesis that after the enactment of the Sarbanes-Oxley Act (SOA) financial statements convey more accurate and reliable corporate information to investors who in turn reflect such improvements in stock prices and test four practical hypotheses that simultaneously feature the degree of information asymmetry, forecast bias, and investor reaction to biased earnings information. The empirical results unanimously suggest that the post-SOA investors take advantage of the improvement in informational efficiency and accuracy and actively adjust for analyst forecast bias in earnings forecasts. The SOA indeed appears to achieve its primary goal of investor protection.

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“…In layman terms, investors "sell winners too early and ride losers too long" (Shefrin and Statman, 1985). Often, prospect theory (Kahneman and Tversky, 1979) is used to explain why investors are prone to this bias (Dacey andZielonka, 2008, Odean, 1998). A prospect theory based explanation of the disposition effect posits that investors are more risk seeking towards stocks held at a loss and are risk seeking towards stocks held at a gain due to the 'S' shaped value (utility) function (Dacey and Zielonka, 2008).…”

Section: Introductionmentioning

confidence: 99%

“…Often, prospect theory (Kahneman and Tversky, 1979) is used to explain why investors are prone to this bias (Dacey andZielonka, 2008, Odean, 1998). A prospect theory based explanation of the disposition effect posits that investors are more risk seeking towards stocks held at a loss and are risk seeking towards stocks held at a gain due to the 'S' shaped value (utility) function (Dacey and Zielonka, 2008). However, recently, researchers have questioned whether prospect theory alone can explain the disposition effect (Barberis and Xiong, 2009, Hens and Vlcek, 2005, Lehenkari, 2012, Summers and Duxbury, 2012.…”

Section: Introductionmentioning

confidence: 99%

Stock market investors' use of stop losses and the disposition effect

Richards

Kodwani

Fenton-O’Creevy

2015

The European Journal of Finance

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The disposition effect is an investment bias where investors hold stocks at a loss longer than stocks at a gain. This bias is associated with poorer investment performance and exhibited to a greater extent by investors with less experience and less sophistication. A method of managing susceptibility to the bias is through use of stop losses. Using the trading records of UK stock market individual investors from 2006 -2009, this paper shows that stop losses used as part of investment decisions are an effective tool for inoculating against the disposition effect. We also show that investors who use stop losses have less experience and that, when not using stop losses, these investors are more reluctant to realise losses than other investors.

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A Detailed Prospect Theory Explanation of the Disposition Effect

Cited by 43 publications

References 16 publications

Taming Models of Prospect Theory in the Wild? Estimation of Vlcek and Hens (2011)

Taming Models of Prospect Theory in the Wild? Estimation of Vlcek and Hens (2011)

Can a securities law improve investor rationality in processing earnings information?

Stock market investors' use of stop losses and the disposition effect

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