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Taming Models of Prospect Theory in the Wild? Estimation of Vlcek and Hens (2011)

SAFE Working Paper No. 146

49 Pages Posted: 1 Oct 2016 Last revised: 12 Apr 2017

Sven Thorsten Jakusch

Goethe University Frankfurt - Department of Finance

Steffen Meyer

Leibniz Universität Hannover

Andreas Hackethal

Goethe University Frankfurt - Faculty of Economics and Business Administration; Goethe University Frankfurt - Research Center SAFE

Date Written: February 28, 2016

Abstract

Shortcomings revealed by experimental and theoretical researchers such as Allais (1953), Rabin (2000) and Rabin and Thaler (2001) that put the classical expected utility paradigm von Neumann and Morgenstern (1947) into question, led to the proposition of alternative and generalized utility functions, that intend to improve descriptive accuracy. The perhaps best known among those alternative preference theories, that has attracted much popularity among economists, is the so called Prospect Theory by Kahneman and Tversky (1979) and Tversky and Kahneman (1992). Its distinctive features, governed by its set of risk parameters such as risk sensitivity, loss aversion and decision weights, stimulated a series of economic and financial models that build on the previously estimated parameter values by Tversky and Kahneman (1992) to analyze and explain various empirical phenomena for which expected utility doesn't seem to offer a satisfying rationale. In this paper, after providing a brief overview of the relevant literature, we take a closer look at one of those papers, the trading model of Vlcek and Hens (2011) and analyze its implications on Prospect Theory parameters using an adopted maximum likelihood approach for a dataset of 656 individual investors from a large German discount brokerage firm. We find evidence that investors in our dataset are moderately averse to large losses and display high risk sensitivity, supporting the main assumptions of Prospect Theory.

Keywords: Prospect Theory, Parameter Elicitation, Investors Heterogeneity

JEL Classification: C35, C51, C52, G02, G11

Suggested Citation

Jakusch, Sven Thorsten and Meyer, Steffen and Hackethal, Andreas, Taming Models of Prospect Theory in the Wild? Estimation of Vlcek and Hens (2011) (February 28, 2016). SAFE Working Paper No. 146. Available at SSRN: https://ssrn.com/abstract=2845338 or http://dx.doi.org/10.2139/ssrn.2845338

Sven Thorsten Jakusch (Contact Author)

Goethe University Frankfurt - Department of Finance ( email )

Mertonstr. 17
Frankfurt, 60054
Germany

Steffen Meyer

Leibniz Universität Hannover ( email )

Königsworther Platz 1
Hannover, DE 30167
Germany

Andreas Hackethal

Goethe University Frankfurt - Faculty of Economics and Business Administration ( email )

Theodor-W.-Adorno Platz 3
Frankfurt am Main, 60323
Germany

Goethe University Frankfurt - Research Center SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

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