Until the bitter end: On prospect theory in a dynamic context
Ebert,S. Strack,P.
Ebert,S.
Strack,P.
Abstract
Many economic and financial decisions depend crucially on their timing. People decide when to invest in a project, when to liquidate assets, or when to stop gambling in a casino. We provide a general result on prospect theory decision makers who are unaware of the time-inconsistency induced by probability weighting. If a market offers a sufficiently rich set of investment strategies, then such naïve investors postpone their stopping decisions indefinitely. We illustrate the drastic consequences of this never-stopping result, and conclude that probability distortion in combination with naïveté leads to unrealistic predictions for a wide range of dynamic setups.
Description
Date
2015-04
Journal Title
Journal ISSN
Volume Title
Publisher
Research Projects
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Journal Issue
Keywords
behavioral economics, disposition effect, irreversible investment, prospect theory, skewness preference, time-inconsistency, G02 - Behavioral Finance: Underlying Principles, D03 - Behavioral Microeconomics ; Underlying Principles, D81 - Criteria for Decision-Making under Risk and Uncertainty
Citation
Ebert, S & Strack, P 2015, 'Until the bitter end : On prospect theory in a dynamic context', American Economic Review, vol. 105, no. 4, pp. 1618-1633. https://doi.org/10.1257/aer.20130896