WEAKNESS OF PROSPECT THEORY • Not Readily Expandable : The original paper outlining prospect theory by Kahneman and Tverski importantly noted that the theory was developed for one shot gambles and that any application to dynamic contextual situations must wait for further research on how people react to sequential gains or losses. It is to this research we turn to draw conclusions when applying prospect theory to dynamic situations. • Coding Process Fragility: The entire decision making process can be derailed at the coding process. At this point the process is highly susceptible to how problems are framed and presented and by the norms, habits and expectation of the decision maker. • Real World Anomalies : There are a number of empirical …show more content…
CONCLUSION Here is a summary of what we've covered: • Conventional finance is based on the theories which describe people for the most part behave logically and rationally. People started to question this point of view as there have been anomalies, which are events that conventional finance has a difficult time in explaining. • Three of the biggest contributors to the field are psychologists, Drs. Daniel Kahneman and Amos Tversky, and economist, Richard Thaler. • The concept of anchoring draws upon the tendency for us to attach or "anchor" our thoughts around a reference point despite the fact that it may not have any logical relevance to the decision at hand. • Mental accounting refers to the tendency for people to divide their money into separate accounts based on criteria like the source and intent for the money. Furthermore, the importance of the funds in each account also varies depending upon the money's source and
Using imagery of a tilted table with three legs, the authors have us visualize a situation in which one leg is shorter than the other two causing the table to tilt. We can affect a quick fix by putting something under the shorter leg. When we experience emotions such as...
Most humans have some thought on what is right and what is wrong, so being consciously aware of the of the shortcomings produced by a broken system will cause individuals to actively avoid using them. For instance, two men are discussion pay for a future job. Knowing that whoever presents the first number will have the upper hand in the rest of the negotiating process they both decide to avoid the process by writing down the number without having any numerical input prior. In doing so, the two can avoid falling victim to the anchoring problem. When convicting a man of kidnapping, while it may not fit the heuristic of that crime, humans must be able to recognize that there was still a crime committed and the man needs to be punished. This can be done by finding a crime that more closely fits his actions or even changing the widely accepted believe and definition of the crime so as not to let men like this go free in the future. While initially the problems see bad, it can be used to create better in the
In the 1920s, it seemed as if the stock market was the safest and easiest way of gaining money. When people heard of this, they started to purchase stocks as well, but by stock speculation. Stock speculation was the purchasing of stocks without any knowledge of the company’s financial situation, meaning people just assumed that every stock would give them a profit. To make matters worse, banks began loaning out money to investors, in order for them to purchase stocks. Soon enough, in early 1929, banks were receiving many warnings about loaning too much money. However, this did not pose a real threat to banks or investors, for they thought that the stock market was just going to keep on going up. Unfortunately, this was not the
“People are very complex. And for a psychologist, you get fascinated by the complexity of human beings, and that is what I have lived with, you know, in my career all of my life, is the complexity of human beings” - Daniel Kahneman.
Flawed financial innovations: the implementation of innovations in investment instruments such as derivatives, securitization and auction-rate securities before markets. The indispensable fault in them is that it was difficult to determine their prices. “Originate to distribute securities” was substituted by securitization which facilitated the increase in ...
The efficient market, as one of the pillars of neoclassical finance, asserts that financial markets are efficient on information. The efficient market hypothesis suggests that there is no trading system based on currently available information that could be expected to generate excess risk-adjusted returns consistently as this information is already reflected in current prices. However, EMH has been the most controversial subject of research in the fields of financial economics during the last 40 years. “Behavioural finance, however, is now seriously challenging this premise by arguing that people are clearly not rational” (Ross, (2002)). Behavioral finance uses facts from psychology and other human sciences in order to explain human investors’ behaviors.
Boneau, C. A., Kimble, G. A., and Wertheimer, M. (1996) Portraits of Pioneers in Psychology, Volume II. Washington D.C. and Mahwah, NJ: American Psychological Association & Erlbaum Associates, Inc.
Prospect theory is a descriptive model concerning the issue of decision making under risk. The theory stated that people tend to made decision by examining the potential gain and loss comparing to reference point and exhibit certain kinds of heuristics and biases in this process such as certainty effect, reflection effect, probabilistic insurance and isolation effect. It also divided choice process into editing phases and the subsequent phase of evaluation, which were modified to framing and valuation phases in the later version (Kahneman and Tversky, 1979, Tversky and Kahneman, 1992).
Finance is a field that had always fascinated me right from my undergraduate college days. What make me interested in this particular field of study are the art of finance and the complexity of investment market which would allow me to employ my personal skills, such as analytical and communication skills, along with my personal characteristics such as dedication and compassion for what I do. As one of the most important sector in the world, I believe it would provide me with a broad range of career options.
There is a lot of research work going on in this particular field, more so since the crisis of 2008. The purpose of this article was to make readers aware of the subject .Behavioral finance is an interesting mix of logics, psychology and economics. Budding investors and management students should look into this in more detail so that they are better equipped to make financial decisions.
The theorist I chose was Maslow, he was born in 1908 in Brooklyn, New York. He was the first of seven children born to his parents, Jewish immigrants from Russia. His parents, hoping for the best for their children in the New World, pushed him hard for academic success. He became the psychologist who many people consider the founder of a movement called humanistic psychology. The movement developed as a revolt against behaviorism and psychoanalysis, the two most popular psychological views of the mid- 1900’s. Humanistic psychologists believe individuals are controlled by their own values and choices and not by the environment, as behaviorists think, or by unconscious drives, as psychoanalyst believe. Maslow stressed the importance of studying well-adjusted people instead of just the disturbed ones.
Every day, many people question my passion for pursuing accounting as a profession and the first answer I think of is that I am good with numbers. However, advancing in the field has made me realize that my passion is not only based on figures. Growing up as a kid, I was privileged to have a piggy account where I would save as little as fifty cents per week. Since my parents rewarded me in monetary value as a positive reinforcement in cases of good behaviour, I was motivated to maintain good manners so long as my savings increased. As time went by, I realized I had saved way “too much” money for a little child. The challenge came in the management of the funds because I was focused on spending more on pleasurable activities. However, the guidance of my parents enabled me to prioritize on the more important things and save more. I took interest in managing may own account as a child and even pursued accounting courses in high school. The interest grew deeper because I gained more insight on the facts about accounting and the career. Also, I believed that it is career that one would be self-employed thereby avoiding the dilemmas of lacking jobs after graduating. For instance, one would easily start their own business and manage their finances comfortably.
Financial theories are the building blocks of today's corporate world. "The basic building blocks of finance theory lay the foundation for many modern tools used in areas such asset pricing and investment. Many of these theoretical concepts such as general equilibrium analysis, information economics and theory of contracts are firmly rooted in classical Microeconomics" (Oaktree, 2005)
Accounting itself is a system that people has been using for thousands of years, the system records financial information about a person or business, businesses use it in order to be able to keep and track their financial accounts and other financial information in a safe and efficient way. (Brooks, 2012)