How are people differentiating the meaning of loss aversion between Prospect Theory and Behavioral Portfolio Theory?
GRACIAS!
Prospect theory goes beyond “bounded rationality” by assuming that investors are loss averse rather than risk averse (as assumed by bounded rationality). BPT is based on this same assumption that investors are loss averse instead of risk averse.
Academics tend to use “utility” to describe enjoyment and contend that we prefer instances that maximize our utility. The prospect theory can be used to explain quite a few illogical financial behaviors.
Prospect theory and loss aversion is synonomous.
my understanding:
1)loss aversion is what brings the contrast between ‘Prospect Theory’ and ‘Expected Utility Theory’.
in ‘Prospect Theory’, the person is loss-averse -> s-shape utlity curve (cfa book vol2 p26, http://en.wikipedia.org/wiki/Prospect_theory), in brief, risk-seeking with losses & risk-averse with gains
in ‘Expected Utility Theory’, the person can be risk-averse, risk-neutral or risk-seeking -> concave, linear, convex utility curve respectively
- Behavioral Portfolio Theory (correlation is not taken into account) is compared with Mean-variance (covariance is taken into account)
different layers, related to mental accounting biases (vol 2 p124)
Even in expected utility theory, the utility curve is S-shaped. The difference between the curve in expected utility theory and prospect theory is that the curve is the former is symmetric (a loss of a given amount is exactly as bad as a gain of the same amount is good), while the curve in the latter is asymmetric (a loss of a given amount is worse (_ more _ bad) than a gain of the same amount is good).