Utility or prospect theory?

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derswap07

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Reading 6 Q 5 :
Statement 6
(from a client): “I follow a disciplined approach to investing. When a stock has appreciated by 15 percent, I sell it. Also, I sell a stock when its price has declined by 25 percent from my initial purchase price.”
The client of Statement 6 is most likely behaving consistently with:
  1. prospect theory.
  2. expected utility theory.
  3. behavioral portfolio theory.
????
 
I would go with prospect theory - where a gain is valued more highly than a loss of similar magnitude. If he was acting rationally he would sell at a 25% g/l
Behavioral portfolio theory is the idea that an investor constructs a portfolio in layers - leading to risk polarization of assets, and there is no discussion of his utility preferences and the diminishing marginal return in wealth levels/risk aversion. Prospect theory is the only one that fits here.
 
B. Expected utility theory. As a person exhibits risk aversion. If he exhibits loss aversion (as in prospect theory), he would buy more when he loses money. So A is not correct answer. C definitely is not an answer as it does not indicate anything about portfolio.
what is the answer?
 
B, he is a rational investor. Ask me how i know this, because i got it wrong the first time and still think its a bs question
 
B)
Can’t be Prospect Theory, since that deals with “selling winners, and holding on to losers in an attempt to break even”. Here the client follows a disciplined rule of when to sell (for both winners + losers).
Furthermore, his rule follows a strict % gain or loss guideline, so that takes the Behavioral element out.
 
I don’t think you’d sell at a 25% loss under Prospect Theory. B
 
We’re all wrong!
Answer is C.
“C is correct. The client of statement 6 is having consistently with behavioral portfolio theory. The clinet sells and holds a stock not because of the stocks potential but rather from a fear of the stock declining in value and gains dissipating and an aversion to realizing losses. Loss-aversion in prospect theory is discussed from a different perspective”
 
After checking, what the client was doing is called rule-based decision.
So A is wrong.
 
Galli wrote:
We’re all wrong!
Answer is C.
“C is correct. The client of statement 6 is having consistently with behavioral portfolio theory. The clinet sells and holds a stock not because of the stocks potential but rather from a fear of the stock declining in value and gains dissipating and an aversion to realizing losses. Loss-aversion in prospect theory is discussed from a different perspective”
Click to expand...
(╯°□°)╯︵ ┻━┻
What’s the different fucking perspective? Fuck this question
 
just my take before I bury this question forever:
A) Incorrect because Prospect theory talks about yielding more utility from a loss turning into a gain over a gain into a larger gain (s-curve chart). This tricked me.
B) is incorrect because this person is not a utility maximizing investor - They are holding onto a loser yet cuts a winner short (-25% max loss vs 15% max gain)
C) is correct because this person holds onto losers while cutting winners off early.
*shrug
 
This was a close call. Although I still feel B is not an incorrect answer, C also makes sense if we closely at the % (sell gains at 15% and sell losers at 25% which is much higher).
 
Isn’t behavior portfolio theory talking about structure portfolio in layers?
I thought B is better than C.
 
^ yeah, BPT is the one with the layers of risk - not sure how that comes into play with this question.
 
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