The Nature of Rationality

We present a new theory of decision under uncertainty: third-generation prospect theory (PT3). This retains the predictive power of previous versions of prospect theory, but extends that theory by allowing reference points to be uncertain while decision weights are specified in a rank-dependent way. We show that PT3 preferences respect a state-conditional form of stochastic dominance. The theory predicts the observed tendency for willingness-to-accept valuations of lotteries to be greater than willingness-to-pay valuations. When PT3 is made operational by using simple functional forms with parameter values derived from existing experimental evidence, it predicts observed patterns of the preference reversal phenomenon.

/pdf/third-generation-prospect-theory-5eg3c8a99u.pdf

Third-generation prospect theory

Ulysses and the Sirens

http://www.economists.nl/files/20090710-AcceptedProof.pdf

A parameter-free analysis of the utility of money for the general population under prospect theory

Several studies have shown that aspiration levels are a relevant aspect of decision making. We develop a model that takes this into account. We include the overall probabilities of success and failure, i.e. the probabilities of reaching and not reaching the aspiration level, into an expected utility representation. This turns out to be equivalent, in a mathematical sense, to expected utility with a discontinuous utility function. We give a behavioral foundation to the proposed model and provide conditions to determine the relative weights of the overall probabilities of success and failure. The model leads to several predictions that fit empirical evidence. Most notably, an aspiration level reinforces loss aversion, can account for simultaneous risk-averse and risk-seeking behavior, and can explain choices violating the mean-variance approach.

https://papers.ssrn.com/sol3/Delivery.cfm?abstractid=1130544

Aspiration Level, Probability of Success and Failure, and Expected Utility

https://www.repository.cam.ac.uk/bitstream/handle/1810/131568/cwpe0458.pdf;sequence=1

The behavioural components of risk aversion

We implement the Cumulative Prospect Theory (CPT) framework (Tversky and Kahneman 1992) into a model of individual asset allocation, building on earlier work by Hwang and Satchell (2003) where they derive explicit formulae for the asset allocation decision using a loss aversion utility function We apply Prelec’s probability weighting function (1998) to continuous distributions and derive the formulae for the optimal asset allocation between risky and safe assets US equity returns data are used to examine the feasible parameter space The earlier results of Hwang and Satchell are confirmed and the more complex model is compatible with observed equity proportions The parameters are highly interconnected, but feasible combinations indicate that more inverse-S shaped deviations from linear probability weightings are associated with lower risk taking behaviour

Continuous Cumulative Prospect Theory and Individual Asset Allocation

https://www.dectech.co.uk/our_company/papers/dectech_2009_reason_based_judgments.pdf

Reason-based judgments: Using reasons to decouple perceived price–quality correlation

PART 1- The Current Paradigm: MPT (Modern Portfolio Theory) Chapter 1: Modern Portfolio Theory as it Stands Chapter 2: Challenges to MPT: Theoretical-the assumptions are not thus Chapter 3: Challenges to MPT: Empirical-the world is not thus Chapter 4: Challenges to MPT: Behavioural-people are not thus Chapter 5: Describing the Overall Framework: Investors and Investments PART 2- Amending MPT: Getting to BMPT Chapter 1:Investors-The Rational Investor Chapter 2: Investments-Extracting Value from the long-term Chapter 3: Investments-Extracting Value from the short-term Chapter 4: bringing it together, the new BMPT paradigm PART 3- Emotional Insurance: Sticking with the Journey Chapter 1: Investors- the emotional investor Chapter 2: Investments- Constraining the rational portfolio PART 4- Practical Implications Chapter 1: The BMPT and Wealth Management Chapter 2: The BMPT and the Pension Industry Chapter 3: The BMPT and Asset Management

http://www.dlfiles24.com/pdf79/175830973-behavioral_investment_management_an_efficient_alternative_to_modern_portfolio_theory_arnaud_de_servigny.pdf

Behavioral Investment Management: An Efficient Alternative to Modern Portfolio Theory

With Keynes (1936), it is part of accepted theory that we have different motives for saving, including the need to secure means for the future. To bridge the gap between motives and observed behaviour, we assume it is necessary to understand how people actually try to achieve their saving goals. A new method of visualising existing saving concepts is introduced, which shows that individuals apply a range of saving strategies to organise their finances. Based on a financial personality survey it is shown how external as well as internal control for saving can be improved systematically.

/pdf/note-on-ways-of-saving-mental-mechanisms-as-tools-for-self-28stbbjrz3.pdf

Greg B. Davies

Papers

The behavioural components of risk aversion

Continuous Cumulative Prospect Theory and Individual Asset Allocation

Reason-based judgments: Using reasons to decouple perceived price–quality correlation

Behavioral Investment Management: An Efficient Alternative to Modern Portfolio Theory

Note on ways of saving: mental mechanisms as tools for self-control?