Prospect theory and mean-variance analysis

Haim Levy; Moshe Levy

doi:10.1093/rfs/hhg062

Prospect theory and mean-variance analysis

Haim Levy^*, Moshe Levy

^*Corresponding author for this work

Business Administration

Research output: Contribution to journal › Review article › peer-review

148 Scopus citations

Abstract

The experimental results of prospect theory (PT) reveal suggest that investors make decisions based on change of wealth rather than total wealth, that preferences are S-shaped with a risk-seeking segment, and that probabilities are subjectively distorted. This article shows that while PT's findings are in sharp contradiction to the foundations of mean-variance (MV) analysis, counterintuitively, when diversification between assets is allowed, the MV and PT-efficient sets almost coincide. Thus one can employ the MV optimization algorithm to construct PT-efficient portfolios.

Original language	English
Pages (from-to)	1015-1041
Number of pages	27
Journal	Review of Financial Studies
Volume	17
Issue number	4
DOIs	https://doi.org/10.1093/rfs/hhg062
State	Published - Dec 2004

Access to Document

10.1093/rfs/hhg062

Cite this

@article{c2adcae7e22c41e9b8438da20ffbd9a5,

title = "Prospect theory and mean-variance analysis",

abstract = "The experimental results of prospect theory (PT) reveal suggest that investors make decisions based on change of wealth rather than total wealth, that preferences are S-shaped with a risk-seeking segment, and that probabilities are subjectively distorted. This article shows that while PT's findings are in sharp contradiction to the foundations of mean-variance (MV) analysis, counterintuitively, when diversification between assets is allowed, the MV and PT-efficient sets almost coincide. Thus one can employ the MV optimization algorithm to construct PT-efficient portfolios.",

author = "Haim Levy and Moshe Levy",

year = "2004",

month = dec,

doi = "10.1093/rfs/hhg062",

language = "אנגלית",

volume = "17",

pages = "1015--1041",

journal = "Review of Financial Studies",

issn = "0893-9454",

publisher = "Oxford University Press",

number = "4",

}

TY - JOUR

T1 - Prospect theory and mean-variance analysis

AU - Levy, Haim

AU - Levy, Moshe

PY - 2004/12

Y1 - 2004/12

N2 - The experimental results of prospect theory (PT) reveal suggest that investors make decisions based on change of wealth rather than total wealth, that preferences are S-shaped with a risk-seeking segment, and that probabilities are subjectively distorted. This article shows that while PT's findings are in sharp contradiction to the foundations of mean-variance (MV) analysis, counterintuitively, when diversification between assets is allowed, the MV and PT-efficient sets almost coincide. Thus one can employ the MV optimization algorithm to construct PT-efficient portfolios.

AB - The experimental results of prospect theory (PT) reveal suggest that investors make decisions based on change of wealth rather than total wealth, that preferences are S-shaped with a risk-seeking segment, and that probabilities are subjectively distorted. This article shows that while PT's findings are in sharp contradiction to the foundations of mean-variance (MV) analysis, counterintuitively, when diversification between assets is allowed, the MV and PT-efficient sets almost coincide. Thus one can employ the MV optimization algorithm to construct PT-efficient portfolios.

UR - http://www.scopus.com/inward/record.url?scp=7044247712&partnerID=8YFLogxK

U2 - 10.1093/rfs/hhg062

DO - 10.1093/rfs/hhg062

M3 - ???researchoutput.researchoutputtypes.contributiontojournal.systematicreview???

AN - SCOPUS:7044247712

SN - 0893-9454

VL - 17

SP - 1015

EP - 1041

JO - Review of Financial Studies

JF - Review of Financial Studies

IS - 4

ER -

Prospect theory and mean-variance analysis

Abstract

Access to Document

Other files and links

Fingerprint

Cite this