Prospect theory, constant relative risk aversion, and the investment horizon

Haim Levy; Moshe Levy

doi:10.1371/journal.pone.0248904

Prospect theory, constant relative risk aversion, and the investment horizon

Haim Levy, Moshe Levy^*

^*Corresponding author for this work

BA Business Department

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

4 Scopus citations

Abstract

Prospect Theory (PT) and Constant-Relative-Risk-Aversion (CRRA) preferences have clear-cut and very different implications for the optimal asset allocation between a riskless asset and a risky stock as a function of the investment horizon. While CRRA implies that the optimal allocation is independent of the horizon, we show that PT implies a dramatic and discontinuous “jump” in the optimal allocation as the horizon increases. We experimentally test these predictions at the individual level. We find rather strong support for CRRA, but very little support for PT.

Original language	English
Article number	e0248904
Journal	PLoS ONE
Volume	16
Issue number	4 April
DOIs	https://doi.org/10.1371/journal.pone.0248904
State	Published - Apr 2021

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Publisher Copyright:
Copyright: © 2021 Levy, Levy. This is an open access article distributed under the terms of the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original author and source are credited.

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Prospect theory, constant relative risk aversion, and the investment horizon

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