History-Dependent Risk Preferences: Evidence from Individual Choices and Implications for the Disposition Effect

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Abstract

Using trading data from a sports-wagering market, we estimate individuals' dynamic risk preferences within the prospect-theory paradigm. This market's experimental-like features facilitate preference estimation, and our long panel enables us to study whether preferences vary across individuals and depend on earlier outcomes. Our estimates extend support for experimental findings — mild utility curvature, moderate loss aversion, and probability overweighting of extreme outcomes — to a market setting and reveal that preferences are heterogeneous and history-dependent. Applying our estimates to a portfolio choice problem, we show prospect theory can better explain the prevalence of the disposition effect than previously thought.
Original languageEnglish
Pages (from-to)3674–3718
JournalREVIEW OF FINANCIAL STUDIES
Volume33
Issue number8
Early online date22 Oct 2019
DOIs
Publication statusPublished - Aug 2020

Keywords

  • Risk Preferences
  • State Dependence
  • History Dependence
  • Heterogeneity
  • Prospect Theory
  • Disposition Effect

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