Prospect theory and institutional investors

• Main Authors: TEO, Melvyn, O'CONNELL, Paul G. J.
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2003
• Subjects: institutional investors; past performance; loss aversion; Finance and Financial Management; Portfolio and Security Analysis
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/5231; https://ink.library.smu.edu.sg/context/lkcsb_research/article/6230/viewcontent/SSRN_id457741__1_.pdf
• Institution: Singapore Management University

There is ample evidence that past performance affects the trading decisions of individual investors. This paper looks at this issue using a detailed database of currency trading decisions of institutional investors. Past performance manifestly affects currency risk-taking in this group, but the sign and magnitude of the effect runs counter to much of the existing theory and evidence. There is no evidence whatsoever of disposition effects; rather, the dominant characteristic is aggressive risk reduction in the wake of losses. This effect is more prominent later in the year, and among older and more experienced funds. A modified version of the loss aversion model of Barberis, Huang and Santos (2001) offers the best hope of adequately accounting for the observed behavior.