Open AccessProspect theory, constant relative risk aversion, and the investment horizon
Author(s) -
Haim Levy,
Moshe Levy
Publication year - 2021
Publication title -
plos one
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.99
H-Index - 332
ISSN - 1932-6203
DOI - 10.1371/journal.pone.0248904
Subject(s) - economics , jump , constant (computer programming) , horizon , asset allocation , risk aversion (psychology) , investment (military) , prospect theory , stock (firearms) , time horizon , econometrics , asset (computer security) , expected utility hypothesis , mathematical economics , microeconomics , financial economics , mathematics , computer science , physics , finance , engineering , computer security , law , portfolio , geometry , quantum mechanics , political science , programming language , mechanical engineering , politics
Prospect Theory (PT) and Constant-Relative-Risk-Aversion (CRRA) preferences have clear-cut and very different implications for the optimal asset allocation between a riskless asset and a risky stock as a function of the investment horizon. While CRRA implies that the optimal allocation is independent of the horizon, we show that PT implies a dramatic and discontinuous “jump” in the optimal allocation as the horizon increases. We experimentally test these predictions at the individual level. We find rather strong support for CRRA, but very little support for PT.