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Summary Of Prospect Theory

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Consider one of the most influential theories in behavioral finance, Prospect Theory, which is developed by Daniel Kahneman and Amos Tversky with their published paper in 1979, investors value gains and losses differently. Losses have more emotional impact to investors than an equivalent amount of gains. Prospect theory states that people are risk-averse in the domain of gains and risk-seeking in the domain of losses; according to a more specific behavior pattern (fourfold pattern of risk, Tversky & Kahneman, 1992), people are risk-averse for gains with high probability but risk-seeking for gains with low probability, while people are risk-seeking for losses with high probability but risk-averse for losses with low probability (Tversky & Kahneman, …show more content…

Additionally, trading volume should increase when the price of an IPO with a negative initial return exceeds the offer price for the first time. Kaustia (2004) finds support for the aggregate impact from the disposition effect on the subsample of negative initial return IPOs. Kaustia (2004) states that trading volume is clearly suppressed below the offer price for negative initial return IPOs, and turnover increases significantly at the time the stock price exceeds the offer price for the first time and continues to get higher while the stock is trading above the offer price. In this paper I inspect IPO trading volume and have some different findings that trading volume is significantly suppressed below the offer price for IPOs in 2003-2007 which is defined as the before-crisis period in Section 2 of this paper, and the effect does not continue to be significant during the following weeks since the offer. In addition, this paper also finds that trading volume is not significantly suppressed below the offer price for IPOs in the after-crisis period (details of period definition are discussed in Section 2). In this paper I also find that there is no significant difference in trading volume between before-crisis and after-crisis …show more content…

Shefrin & Statman (1985) suggest the purchase price to be the benchmark for investors who are unwilling to realize losses. Weber & Camerer (1998) suggest both the price of the previous period and purchase price to be important reference prices. Gneezy (2000) states the maximum and minimum stock prices are also potential reference points and the maximum stock price is even more significant than the purchase price. Heath et al. (1999) and Poteshman & Serbin (2003) state that attaining new highs in stock prices is a significant reference price in employee stock options and standardized exchange traded stock options respectively. Furthermore, Grinblatt & Keloharju (2001) and Kaustia (2004) find that new highs and lows of the past month are both important reference prices. In this paper I inspect the effect of different reference prices. The results are consistent with Kaustia (2004), which shows the relative importance of maximum and minimum stock prices as reference prices. Attaining new highs and lows over the previous month can increase the daily turnover significantly as similar as the results of Kaustia (2004). The effect is very significant for all subsamples of this paper, where new highs are more important by comparing their estimate

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