Consistent with Bernoulli's interpretation of utility,
investment managers determine their clients' preference for risk by directly
asking clients about their willingness to take risks. Many investors find
answering such questions difficult. Consistent with Simon's theory of bounded
rationality, other investment managers ask clients how much money they will
eventually want to withdraw from their investment account to meet education,
retirement, or other investment goals. Many clients find such questions easier
to answer. This paper aims to show how the
target-oriented utility integrates these two approaches by interpreting the
utility of wealth as the probability of the client needing that level of wealth
to achieve their investment goals. In this case, a client's willingness to take
risks reflects their uncertainty about how much wealth will be required to
achieve their targets. The target-oriented utility predicts loss-aversion
during bull markets where winning stocks are sold too early and gainseeking
where losing stocks are held too long in bear markets. Our results offer a
normative explanation to the disposition effect, which is the prevalent biased
behavior that drives investors to "sell winners too early" in bull
markets and to "ride losers too long" in bear markets.
Author(s) Details
Robert Bordley
Integrative Sciences Division, University of Michigan, Ann Arbor, USA.
Author(s) Details
Robert Bordley
Integrative Sciences Division, University of Michigan, Ann Arbor, USA.
Luisa Tibiletti
Department of Management, University of Torino, Italy.
View Book :- http://bp.bookpi.org/index.php/bpi/catalog/book/199
Department of Management, University of Torino, Italy.
View Book :- http://bp.bookpi.org/index.php/bpi/catalog/book/199
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