Risk aversion

Guys, we have loss aversion in Prospect theory and Behavioral portfolio theory.

Do u know the differences?

A case in point would be the following:

” I follow a disciplined approach to investing. When a stock has appreciated by 15%, I sell it. Also, I sell a stock when it’s prices has declined by 25% from my initial purchase price.”

The answer is BPT. Curriculum says loss aversion was discussed from a different perspective.

but, what are the differences?

Loss aversion = disliking equal losses more than liking equal gains. I.e. in your scenario, he is loss averse as he doesn’t sell until it has appreciated further. It leads them to selling winners and holding losers.

Risk aversion = you’d rather take guaranteed return rather than betting for higher return. High risk aversion might be investing in default free bonds because you know you’ll get paid 2% rather than gambling on stocks.

Remember that loss aversion essentially states that you are selling winners too soon and holding on to losers for too long.

So loss aversion does not fit here.

Yup, in this case, it was not equal loss, as compared to equal gains. Gain is set at 15% level while losses at 25%, another 10% further losses…

I thought this case is stating loss aversion, the client yields the profits too soon, at 15 % while holding on losses to another 10%…then why it is not loss aversion under prospect?

BPT relates to constructing portfolios in layers without accounting for the correlation between layers, i.e. might not be as well diversified as it appears. In other words, I’m not sure why the answer here is BPT and not PT.

Reading 5 EOC 5