Behavioral Finance Reading 5 EOC #5 Behavioral Portfolio Theory vs Prospect Theory

I don’t understand why selling the stock when it goes up by 15% and goes down by 25% is consistent with Behavioral Portfolio Theory, not Prospect Theory?

I thought BPT is about constructing portfolio in layers according to goals, Prospect theory is about how investment decision is made based on how gain/loss is evaluated. Looks like this situation fits better into Prospect theory instead of BPT?

Behavioral Finance always throws me off. It’s the most confusing part in Level III.

Nobody taking this one?

First, agreed regarding BF being confusing.

Second - and I hesitate to plant a flag on this given how easy it is to be wrong on these types of assertions - but I’ll go ahead and say it: I think the solution is wrong. I went back and re-read the BPT section, as well as the prospect theory section, and I can’t see how the correct answer could possibly be BPT.

Thanks for the response, great minds think alike :slight_smile:

Somehow it’s not in the CFAI 2017 erreta…maybe we should email them? Unless someone else can prove that we are wrong here…

Agreed…I was reviewing today, pretty sure that’s prospect theory. The relative change and all that jazz, risk seeking at loss and risk adverse at gain. The answer is pretty poop as well…that PT deals with loss aversion from another way…crappy question IMO.

wrong thread…whoops

I’m with you…I got really upset when I see more errors on them, both in the books and the past exams.

I have never read a book that many times before in my entire life, and I don’t read the Bible (not a religious person). Has anyone read a book as many times as CFA materials other than the Bible? So it should be nearly as accurate as the Bible IMO.

These questions are fine, they are meant to be like this to see who actually understands the underlying information and who’s just trying to memorize stuff. If everything was plain vanilla we would all have our charters, people need to stop complaining about “unfair” / difficult questions.

Anyways, i’m a believer for self-discovery because you’ll retain the information better. “Prospect theory considers how prospects (alternatives) are perceived based on their framing, how gains and losses are evaluated, and how uncertain outcomes are weighted.” pick out the key words in the CFAI definition and take a look at the statement you posted. There is a key element missing (assuming what you posted is the majority of it)

Well, you can argue that the statement is not completely about Prospect Theory, then how do you prove that it’s Behavioral Portfolio Theory? It’s missing the key elements from BPT as well :construct their portfolios in layers and expectations of returns and attitudes toward risk vary between the layers

If you look at the actual past exams… the questions that come up are more straight forward… either you know it or you don’t

I think you’re missing the fundamental of these concepts and just focusing on the surface level of answers. There is no argue this or maybe that, it’s 100% not prospect theory because it violates loss aversion. There is no partial reason why it could be prospect theory. you’re to focused on seeing the obvious with layers and pyramids and matching. But what you just defined as BPT (bolded & underlined above)… is already in the statement.

sell @ +15% @ -25%


Is your argument that because it’s not being done in an evaluation phase, it’s a set rule…it’s not PT? Because it definitely looks like a double utility curve to me. And it seems focused on relative wealth (% change) vs total wealth.

Curious how it violates loss version. They prefer certain gains (capping winner) and holding onto losses longer. If it was +15 -15, then yeah. But here they sell at 15, and hold on an extra 10% to only sell once that is crossed.

Know the case facts… why are you assuming all this stuff? also what makes you think BPT should be +15 -15?

Re-read the 1st sentence slowly, then re-read Prospect Theory (loss aversion) again.

AlmostDoneIII , while I agree that we should not focus on surface level of answers, unfortunately I’m not convinced by your rationale.

Like what Jsnazz pionted out, it’s too obvious to ignore the graph of double utility function here: selling @ +15% - risk aversion when facing gains (selling winners too soon), vs selling @- 25% - risk seeking when facing losses (holding losers too long). To me, +15% vs -25% is the key.

The words you underlined are not the key words about BPT. BPT is all about constructing portfolio in layers with each layer meeting different goals, which is completely missing from the original statement.

I can’t post CFAI materials here but feel free to check out the definition from Wiki:

Aight, just gonna lay it out as simple as possible.

1st. that wiki definition still doesn’t support what you are saying as “key”… They key to BPT is understanding the philosophy, behavior, underlying driver, thought process, “theory” that leads to portfolio construction. Wiki clearly supports that portfolio construction (your pyramid matching you keep talking about) is just a result of BPT. you can create pyramid matching without having BPT.

2nd. Prospect Theory requires you to have options, 1 loss and 1 gain basically framing 2 scenarios where you will always pick the gain to avoid the pain of loss. 1st sentence he clearly states he follows a disciplined approach… Most likely (best answer) is going to be BPT because it sure aint Prospect theory.

In the end it’s up to you to write whatever you want, but trying to bring in stuff from outside to fudge your answer is always going to lead to a wrong answer. Especially when the case facts have everything you need.

Where’s this question located? It seems familiar but I’ve done so many questions already I can’t place it. I’d like to take a look and draw my own conclusions.

SS5 BF Reading 5 EOC #5 page 46 - take a look and let us know what you think…