Abstract
Many economic and financial decisions depend crucially on their timing. People decide when to invest in a project, when to liquidate assets, or when to stop gambling in a casino. We provide a general result on prospect theory decision makers who are unaware of the time-inconsistency induced by probability weighting. If a market offers a sufficiently rich set of investment strategies, then such naïve investors postpone their stopping decisions indefinitely. We illustrate the drastic consequences of this never-stopping result, and conclude that probability distortion in combination with naïveté leads to unrealistic predictions for a wide range of dynamic setups.
| Original language | English |
|---|---|
| Pages (from-to) | 1618-1633 |
| Journal | American Economic Review |
| Volume | 105 |
| Issue number | 4 |
| DOIs | |
| Publication status | Published - Apr 2015 |
Keywords
- behavioral economics
- disposition effect
- irreversible investment
- prospect theory
- skewness preference
- time-inconsistency