BUSAN,
South Korea, July 30,
2024 /PRNewswire/ -- Previous studies implemented
prospect theory utility in the stock market as a criterion for
investor decision-making and empirically demonstrated its
predictive power. Researchers from Pusan National University recently devised a novel
method for generating investors' subjective decision-making weights
from the cross-sectional stock return distribution of all stocks,
which can enhance the predictive power of existing prospect theory
values in the stock market and successfully explain the investment
performance of a momentum investment strategy.
Prospect theory, proposed by Kahneman and Tversky in 1979, has
been acknowledged as an excellent decision-making theory for the
bounded rationality of investors tending to show cognitive bias
under conditions of uncertainty. In terms of gains and losses
in prospect theory, investors tend to be more sensitive to losses
than equal-magnitude gains (loss aversion). Together, they show
different risk attitudes: risk-averse in the case of gains and
risk-seeking in the case of loss (diminishing sensitivity).
According to a 2016 study by Baberis et al., under the
premise of prospective utility, investors determine the values of
prospect theory for stocks using past return distributions as a
representativeness heuristic. The study defines the past 12-month
return distributions as the heuristic of investor decision-making
based on prospect theory.
Accordingly, a group of researchers led by Professor Cheoljun
Eom from the School of Business at Pusan National University, Korea, recently empirically
investigated whether prospect theory values from the past 12-month
return distributions have the power to predict performance
persistence for the cross-sectional returns of stocks in future
holding periods. Furthermore, as the methods measuring the values
of prospect theory for cross-sectional stock returns improve, they
devised a new measurement of cross-sectional prospect theory value
(CSPTV) to enable cross-sectional comparison among stocks, compared
with the existing prospect theory value (PTV) specific to a single
stock. Their study was made available online on 15 February 2024 and published in Volume 93 of
the International Review of Financial Analysis on
1 May 2024.
"Our work robustly demonstrates the ability of CSPTV
to outdo PTV in terms of predictive power of performance
persistence," remarks Prof. Eom.
The present study, through its research goals and results is
expected to make contributions on several fronts. First, it shows
the predictive power of performance persistence in future holding
periods using PTVs from the past 12-month return distributions.
Particularly, the scope of prospect theory for cross-sectional
stock returns in stock markets has now been successfully expanded
over the past 12 months. Moreover, this work devises a CSPTV
reflecting investors' tendency to compare gains and losses among
stocks cross-sectionally, unlike the PTV specific to a single
stock. The comparative advantage of CSPTV in better capturing the
predictive power of prospect theory compared to PTV is thus
empirically proven. Lastly, this study confirms that PTVs from
the past 12 months can explain both the momentum and disposition
effects observed during the same period. This means that the
information value in a prospect theory portfolio has been robustly
proven to be unique and not redundant for the above effects.
Prof. Eom concludes, "Overall, we anticipate differentiated
contributions from the CSPTV design, which expands the scope of the
existing prospect theory to the past 12-month return distribution
and improves the predictive power of prospect theory in
cross-sectional stock returns."
Reference
Title of original paper: Intermediate
cross-sectional prospect theory value in stock markets: A novel
method
Journal: International Review of Financial
Analysis
DOI: 10.1016/j.irfa.2024.103120
About the institute
Website:
https://www.pusan.ac.kr/eng/Main.do
Media Contact:
Jae-Eun
Lee
82 51 510 7928
380995@email4pr.com
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SOURCE Pusan National University