Behavioral Finance Term Papers

However, when these figures enter the negative domain, people prefer the 80% chance of losing ,000 over the certainty of losing ,000.The existence of this phenomenon can be explained by another tenet of prospect theory: probability weighting.

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Turning to the stock market, investors are prone to keep losing stocks, hoping they will rebound, and are more likely to sell gaining stocks, afraid of a potential downturn.

Historical data indicate that the momentum of a gaining stock is likely to continue and those with a negative return should be sold off.

To account for the deviations from rationality, economic issues are looked at through a psychological lens that more accurately predicts and explains human behavior.

In fact, many of the findings appear intuitive, but only with the emergence of behavioral finance did data and experimentation give credence to these ideas.

According to standard economics, however, people should accept a gamble as long as the positive gain surpasses $100.

This phenomenon only scratches the surface of the influence of loss aversion.

The literature indicates that even experts in their respective fields fall prey to cognitive biases.

It is important for advisors and wealth managers to be aware of biases and mental shortcuts that can impact their decisions.

In other words, the feeling associated with a loss is much stronger than the positive feeling experienced with a gain.

For instance, individuals report that a 50% chance of losing 0 must be offset by a 50% chance of gaining 0.


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