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Until the Bitter End: On Prospect Theory in a Dynamic Context

25 Pages Posted: 16 Feb 2012 Last revised: 15 Dec 2015

Sebastian Ebert

Tilburg University

Philipp Strack

University of California, Berkeley - Department of Economics

Date Written: February 15, 2012

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.

Keywords: Behavioral Economics, Disposition Effect, Irreversible Investment, Prospect Theory, Skewness Preference, Time-Inconsistency

JEL Classification: G02, D03, D81

Suggested Citation

Ebert, Sebastian and Strack, Philipp, Until the Bitter End: On Prospect Theory in a Dynamic Context (February 15, 2012). Available at SSRN: https://ssrn.com/abstract=2005806 or http://dx.doi.org/10.2139/ssrn.2005806

Sebastian Ebert (Contact Author)

Tilburg University ( email )

P.O. Box 90153
Tilburg, DC 5000 LE
Netherlands

Philipp Strack

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
United States

HOME PAGE: http://philippstrack.com

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