Until the bitter end: On prospect theory in a dynamic context

S. Ebert, P. Strack

Research output: Contribution to journalArticleScientificpeer-review

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 languageEnglish
Pages (from-to)1618-1633
JournalAmerican Economic Review
Volume105
Issue number4
DOIs
Publication statusPublished - Apr 2015

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Prospect theory
Prediction
Decision maker
Investors
Investment strategy
Economics
Assets
Probability weighting
Casino
Financial decisions
Probability distortion
Gambling
Time inconsistency

Keywords

  • behavioral economics
  • disposition effect
  • irreversible investment
  • prospect theory
  • skewness preference
  • time-inconsistency

Cite this

Ebert, S. ; Strack, P. / Until the bitter end : On prospect theory in a dynamic context. In: American Economic Review. 2015 ; Vol. 105, No. 4. pp. 1618-1633.
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Until the bitter end : On prospect theory in a dynamic context. / Ebert, S.; Strack, P.

In: American Economic Review, Vol. 105, No. 4, 04.2015, p. 1618-1633.

Research output: Contribution to journalArticleScientificpeer-review

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