The disposition effect is the observation that investors hold winning stocks too long and sell losing stocks too early. A standard explanation of the disposition effect refers to prospect theory and in particular to the asymmetric risk aversion according to which investors are risk averse when faced with gains and risk-seeking when faced with losses. We show that for reasonable parameter values...

In previous models of (cumulative) prospect theory reference-dependence of preferences is imposed beforehand and the location of the reference point is exogenously determined. This note provides a foundation of prospect theory, where reference-dependence is derived from preference conditions and a unique reference point arises endogenously.

Tversky and Kahneman have worked out an appealing model of decision making under uncertainty, involving rankand sign-dependent utilities. This model, cumulative prospect theory (CPT), as well as related models proposed by other authors, has received wide acclaim. Available information and psychological attitude facing ambiguity jointly determine the subjective likelihood values the decision mak...