Behavioural Finance: A User-Oriented Procedure to Assessing Preferences Under Risk
6 Pages Posted: 14 Jun 2014
Date Written: June 12, 2014
According to the behavioral finance theory, agents act coherently with the Kahneman and Tversky prospect paradigms and may violate those dictated by the rational expected utility. From the point of view of real financial markets’ applications, a key question concerns how to eliciting the financial professionals’ risk preferences. In this contribution we propose the benchmarking procedure originally set up by Castagnoli and LiCalzi (1996) and Bordley and LiCalzi (2000) that couples sound axiomatic fundamentals with a user-friendly language. According to the benchmarking modelling, to maximizing the expected cardinal utility is equivalent to maximizing the probability to meet a (uncertain) goal. It follows that the subjective preferences under risk can be expressed in terms of the probability of matching financial benchmarks. Since practitioners may feel more comfortable in answering questions involving perceived probability of meeting commitments than expressing preferences on lotteries’ outcomes, the use of the benchmarking modelling is expected to reduce inconsistency in questionnaires.
Keywords: Prospect Theory, Behavioral Finance, Value function assessment, Loss aversion, Benchmarking procedure
JEL Classification: D81, G11
Suggested Citation: Suggested Citation