Can prospect theory explain the disposition effect? An analysis based on value function

Abstract

Purpose The prospect theory is potentially an essential ingredient in modeling the disposition effect. However, many scholars have tried to explain the disposition effect with the help of prospect theory and they came to opposite conclusions. The purpose of this paper is to examine the impact of value function of the prospect theory on predicting the disposition effect. Design/methodology/approach Lagrange multiplier optimization and dynamic programming method are used to solve the representative investor’s optimal portfolio choice problem. Furthermore, numerical simulation is used to compare the prediction ability of different types of value function. Findings The authors support that the value function has a crucial role in predicting the disposition effect with prospect theory, i.e. the curvature and boundedness of the value function may influence the performance of applying the prospect theory in the disposition effect. They conclude that a piecewise negative exponential value function can predict the disposition effect, while others like the piecewise power value function may not. Originality/value Extant literature about modeling the disposition effect with the prospect theory mostly focus on the time when gain-loss utility occurs or the selection of reference point. This paper based on the value function properties provides a new perspective in analyzing the crucial role that value function has in predicting financial market anomalies.

Dispotition Effect And Momentum

“…Permintaan akan saham perusahaan dari investor disposition akan tergantung dari sejarah performa harga saham tersebut (Bodie et al, 2011). Liu et al (2017) 1985). Sebagian besar penjelasan di atas didasarkan pada analisis kualitatif dan masih ditemukan berbagai hasil yang kontradiktif dari data perdagangan di pasar keuangan nyata (Odean, 1998)…”

Efeito disposição em finanças comportamentais: produção científica a partir de 2015 e perspectivas

“…Ainda que o disposition effect seja amplamente reconhecido, percebe-se que mais autores questionam a convenção da teoria do prospecto como base para o viés. Em suma, autores nesta linha de pesquisa defendem que aspectos relacionados à prospect theory são pouco representativos na análise das causas do efeito disposição (Jiao, 2017;Favreau & Garvey, 2021), ou que a relação da referida teoria com a tendência em realizar ganhos e manter perdas está condicionada aos tipos de modelos construídos (Liu, Zhang, & Zhao, 2018;Meng & Weng, 2018). Neste sentido, é possível que mais estudos sobre a aplicabilidade da teoria do prospecto sobre o efeito disposição sejam realizados nos próximos anos.…”