Prospect theory and liquidation decisions

Albert S. Kyle, Hui Ou-Yang, Wei Xiong

Research output: Contribution to journalArticle

40 Scopus citations

Abstract

We solve a liquidation problem for an agent with preferences consistent with the prospect theory of Kahneman and Tversky [Econometrica 47 (1979) 263-291]. We find that the agent is willing to hold a risky project with a relatively inferior Sharpe ratio if the project is currently making losses, and intends to liquidate it when it breaks even. On the other hand, the agent may liquidate a project with a relatively superior Sharpe ratio if its current profits rise or drop to the break-even point. Our results capture the spirit of the disposition effect and the break-even effect documented in empirical and experimental studies.

Original languageEnglish (US)
Pages (from-to)273-288
Number of pages16
JournalJournal of Economic Theory
Volume129
Issue number1
DOIs
StatePublished - Jul 1 2006

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics

Keywords

  • Break-even effect
  • Disposition effect
  • Liquidation decisions
  • Prospect theory

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