Financial Market Equilibria with Cumulative Prospect Theory Preferences
Journal
Journal of Mathematical Economics
ISSN
0304-4068
ISSN-Digital
1873-1538
Type
journal article
Date Issued
2010-09-20
Author(s)
Abstract
The paper first shows that financial market equilibria need not to exist if agents possess cumulative prospect theory preferences with piecewise-power value functions. This is due to the boundary behavior of the cumulative prospect theory value function, which might cause an infinite short-selling problem. But even when a non-negativity constraint on final wealth is added, non-existence can occur due to the non-convexity of CPT preferences, which might cause discontinuities in the agents' demand functions. This latter observation also implies that concavification arguments which has been used in portfolio allocation problems with CPT preferences do not apply to our general equilibrium setting with finite many agents. Existence of equilibria is established when non-negativity constraints on final wealth are imposed and there is a continuum of agents in the market. However, if the original prospect theory is used instead of cumulative prospect theory, then other discontinuity problems can cause non-existence of market equilibria even in this case.
Language
English
Keywords
Cumulative prospect theory
Prospect theory
General equilibrium model
Non-convex preferences
Continuum of agents
HSG Classification
contribution to scientific community
Refereed
Yes
Publisher
Elsevier
Publisher place
Amsterdam
Volume
46
Number
5
Start page
633
End page
651
Pages
19
Subject(s)
Eprints ID
63182