These extended theories are richer than the original model, and, as a result, have more to offer marketing. The tendency of some investors to hold on to their losing stocks, driven by prospect theory and mental accounting, creates a spread between a stocks fundamental value and its equilibrium price, as well as price underreaction to information. Motivated by prospect theory and mental accounting, our papers model of equilibrium asset prices adds to this literature by explaining why momentum exists in the crosssection of stock returns. Prospect theory mental accounting and momentum pdf prospect theory and mental accounting ptma generates a disposition eect. Prospect theory, mental accounting, and momentum request pdf. Spread convergence, arising from the random evolution of fundamental values and. The evidence indicates that momentum profits have continued in the 1990s, suggesting that. The tendency of some investors to hold on to their losing stocks, driven by prospect theory and mental accounting, creates a. Assume that the exact scientific estimates of the consequences of the programs as follows. Previously, he was at alpha architect, where he focused on business development, firm operations, and blogging on quantitative investing and finance topics. An institutional theory of momentum and reversal by dimitri. The reason is that ptma investors are risk averse over gambles for some stocks and risk loving in gambles for others. Topic 2 prospect theory, framing and mental accounting. Prospect theory, mental accounting, and momentum ideasrepec.
One implication is that we expect to see momentum in stock returns. An institutional theory of momentum and reversal dimitri vayanos and paul woolley nber working paper no. Theory of behavioural finance and its application to property. In mental accounting theory, framing means that the way a person subjectively frames a transaction in their mind will determine the utility they receive or expect. Behavioral finance prospect theory, mental accounting. Mental accounting provides a foundation for the way in which decision makers set reference points for the accounts that determine gains and losses. Prospect theory, mental accounting, and momentum sciencedirect. It is fairly easy to see that if the relevant accounts are pro. Basic premise of theory prospect theory is a behavioral economics theory that evaluates the way people choose between probabilistic alternatives that involve risk. As the theoretical framework of mental accounting is derived from prospect theory kahneman and tversky, 1979. The main idea is that decision makers tend to segregate different types of gambles into separate accounts, and then apply prospect theory to each account by ignoring possible interactions. In contrast to rational expected theory, individuals often make decisions based on both the expected outcome and the risk associated with losses or gains. We propose a rational theory of momentum and reversal based on delegated portfolio management. When the relevant mental accounts employ the cost basis in a stock as the reference point, the starting positions are dictated by the unrealized capital gain or loss.
Prospect theory, mental accounting, and momentum econpapers. I buy on the assumption that they could close the market the next day and not reopen it for five years. This concept is similarly used in prospect theory, and many mental accounting theorists adopt that theory as the value function in their analysis. Prospect theory, mental accounting, and momentum by bing. This paper presents a critique of expected utility theory as a descriptive model of decision making under risk, and develops an alternative model, called prospect theory. Investors tend to hold back the losers of the past. However, although prospect theory factors arose as a descriptive model, it offers no psychological explanations for the processes stated in it. Prospect theory predicts that the propensity to sell a stock declines as its price moves away from the purchase price in either direction. Citations of prospect theory, mental accounting, and momentum.
Prospect theory, mental accounting, and momentum by bing han. The model presented here is consistent with the empirical evidence on the disposition effect. Thalers 1980 mental accounting framework,is perhaps the leading explanation for the disposition effect. A prospect theoretical interpretation of momentum returns 1 introduction according to standard theory, returns on investment strategies might be higher than returns on holding the market portfolio if they carry a higher systematic risk. Reference literature for the momentum factor andrei, d. Mental accounting and loss aversion provide an easy and intuitive explanation for this phenomenon.
Pdf prospect theory, mental accounting, and momentum. Choices among risky prospects exhibit several pervasive effects that are inconsistent with the basic tenets of utility theory. The prospect theory is an economics theory developed by daniel kahneman and amos tversky in 1979. In part 2 of this 3part series well cover a topic called prospect theory. Mental accounting or psychological accounting attempts to describe the process whereby. A competitive investor can invest through an index fund or an active fund run by a manager with unknown ability. Some puzzles addressed by prospecttheory and mental accounting. Two alternative programs to combat the disease have been proposed. Rohit kishore, university of western ydney, s australia. Jul 09, 2019 prospect theory assumes that losses and gains are valued differently, and thus individuals make decisions based on perceived gains instead of perceived losses.
Another issue brought by dick thaler was the mental accounting, another violation of rationality due to the segregation of mental accounts, where people struggles to keep each account black. Lse, cepr and nber paul woolley lse february 9, 20 abstract we propose a theory of momentum and reversal based on. A prospecttheoretical interpretation of momentum returns. Trading data, on the other hand, show that the propensity to sell jumps at zero return, but it is approximately constant over a wide range of losses and increasing or constant over a wide range of gains. The tendency of some investors to hold on to their losing stocks, driven by prospect theory and mental accounting, creates a spread between a stocks fundamental value and its equilibrium price.
The tendency of some investors to hold on to their losing stocks, driven by prospect theory and mental accounting, creates a spread between a stocks. Twelfth annual pacific rim real estate society conference, january 2225, auckland, new zealand. If you continue browsing the site, you agree to the use of cookies on this website. Sorry, we are unable to provide the full text but you may find it at the following locations. Spread convergence, arising from the random evolution of fundamental values and updating of reference prices, generates predictable. The main element of prospect theory is an sshaped value function that is concave risk averse in the domain of gains and convex risk loving in the domain of losses,both measured relative to a reference point. This paper provides a general equilibrium model and.
An institutional theory of momentum and reversal dimitri vayanos. An institutional theory of momentum and reversal dimitri vayanos, paul woolley. Mental accounting is an economic concept established by economist richard thaler, which contends that individuals divide their current and. An evaluation of alternative explanations narasimhan jegadeesh and sheridan titman this paper evaluates various explanations for the profitability of momentum strat egies documented in jegadeesh and titman 1993. On the relationship between concentration of prospect theorymental accounting investors, cointegration, and momentum.
Theory of behavioural finance and its application to property market. Lse, cepr and nber paul woolley lse november 28, 2008 abstract we propose a rational theory of momentum and reversal based on delegated portfolio management. Prospect theory, framing and mental accounting 1 prospect theory prospect. This theory essentially builds on behavioral finance and dives even deeper into the psychology of why people tend not to think as rational as it would seem regarding choice.
On the relationship between concentration of prospect. In this paper we offer an explanation that incorporates further evaluation concepts of prospect theory. The answer to this question requires a general equilibrium analysis. Prospect theory and the disposition effect journal of.
An investor can hold assets through an index or an active fund. Prospect theory, mental accounting, and momentum citeseerx. Nov 01, 2005 read prospect theory, mental accounting, and momentum, journal of financial economics on deepdyve, the largest online rental service for scholarly research with thousands of academic publications available at your fingertips. Lse, cepr and nber paul woolleyy lse december 18, 2010z abstract we propose a rational theory of momentum and reversal based on delegated portfolio man. Prospect theory, mental accounting, and momentum, journal of. D5,d8,g1 abstract we propose a rational theory of momentum and reversal based on delegated portfolio management. David foulke is an operations manager at tradingfront, inc. View notes topic 2 prospect theory, framing and mental accounting from corpfin 7045 at university of adelaide. Spread convergence, arising from the random evolution of fundamental values and updating of. A combination of mental accounting thaler, 1985 and prospect theory kahneman and tversky, 1979 is considered as the plausible explanation for this effect. A read is counted each time someone views a publication summary such as the title, abstract, and list of authors, clicks on a figure, or views or downloads the fulltext. On the relationship between concentration of prospect theory.
Understanding these biases can help you persuade them to take action. Velumoni1 assistant professor, sathyabama university, chennai, india abstract behavioural finance is a rapidly growing area that deals with the influence of psychology on the behaviour of financial practitioners. Grinblatt and han 2005 argue that momentum is the result of prospect theory and mental c alculations combined to create a disposition effect. It is therefore surprising that simple momentum investment strategies seem to contradict this conventional wis. Shefrin and statman 1985 label this evidence as the disposition effect. Prospect theory, mental accounting, and momentum core. May 15, 2016 prospect theory, kahneman and tversky slideshare uses cookies to improve functionality and performance, and to provide you with relevant advertising. Solving some financial puzzles with prospect theory and. Spread convergence, arising from the random evolution of fundamental values and updating of reference prices, generates predictable equilibrium prices. Prospect theory, mental accounting, and differences in. In mental accounting theory, framing means that the way a person subjectively frames a transaction in their. Prospect theory is based on psychophysical models, such as those that. Implications of prospect theory for asset prices and trading volume abstract does prospect theory produce price momentum and returnvolume comovement via the disposition e.
1502 907 257 1343 1516 794 1508 536 901 33 1109 774 1487 605 1541 555 1439 586 292 786 97 84 950 237 919 866 860 679 1141 966 90 389 864 667