Prospect Theory or Behavioral Portfolio Theory?

CFA Level III
#1

Volume 2 Page 45- EOC Question 5.

The client of Statement 6 is most likely behaving consistently with:

A) Prospect Theory

B) Expected Utility Theory

C) Behavioral Portfolio Theory

Correct answer is C. On page 38, where it discusses BPT this is explicitly mentioned so can’t argue with that. But isn’t the loss aversion demonstrated in the statement just as much a behavioral bias rooted in prospect theory? The explanation says loss aversion in prospect theory is discussed from a different perspective …

I don’t really get the difference, prospect theory discusses loss aversion using that S-shaped value function and gives the example of an investor making inconsistent choices (i.e. is risk seeking in the second case) between two gambles, when the expected values of both situations are the same.

In BPT, the disposition effect is evident … selling the winner early and holding onto losers too long. But that can be related to the S-shaped graph and loss aversion as discussed in prospect theory, right?

Would appreciate someone explaining the difference. Thanks.

#2

Prospect theory uses decision weights . There have to be choices and the investor discriminates between them on the basis of the utility function.So if he has to invest in A which delivers a safe low return and B which delivers the same expected return but is framed as if it is more attractive , he may choose B.

In this problem , there are no alternatives framed .The solution choices are just a S-Shaped utility function which is a characteristic of the prospect theory and mantra 5 ( second stanza ) of BPT , you have to veer towards BPT . The individual becomes risk seeking when he is losing on the investment and risk averse when he is gaining on the investment .

When there are no alternative investment choices , just a single decision , choose BPT.

When there are framed decision weights and a loss/gain reference framework , choose prospect theory.

I think about 90% of those that try this one get it wrong , so the text is not good at explaining the precise difference