Henderson, V;
Hobson, D;
Tse, ASL;
(2018)
Probability weighting, stop-loss and the disposition effect.
Journal of Economic Theory
, 178
pp. 360-397.
10.1016/j.jet.2018.10.002.
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Abstract
In this paper we study a continuous-time, optimal stopping model of an asset sale with prospect theory preferences under pre-commitment. We show for a wide range of value and probability weighting functions, including those of Tversky and Kahneman (1992), that the optimal prospect takes the form of a stop-loss threshold and a distribution over gains. It is skewed with a long right tail. This is consistent with both the widespread use of stop-loss strategies in financial markets, and recent experimental evidence. Moreover, our model with probability weighting in tandem with the S-shaped value function makes predictions for the disposition effect which match in magnitude that calculated by Odean (1998).
| Type: | Article |
|---|---|
| Title: | Probability weighting, stop-loss and the disposition effect |
| Open access status: | An open access version is available from UCL Discovery |
| DOI: | 10.1016/j.jet.2018.10.002 |
| Publisher version: | https://doi.org/10.1016/j.jet.2018.10.002 |
| Language: | English |
| Additional information: | This version is the author accepted manuscript. For information on re-use, please refer to the publisher’s terms and conditions. |
| Keywords: | Prospect theory; Behavioral economics; Disposition effect; Investor trading behavior; Probability weighting |
| UCL classification: | UCL UCL > Provost and Vice Provost Offices > UCL BEAMS UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Maths and Physical Sciences UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Maths and Physical Sciences > Dept of Mathematics |
| URI: | https://discovery.ucl.ac.uk/id/eprint/10137459 |
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