Behavioural Finance: A Re-Examination of Prospect Theory

Abstract

Behavioural finance has received a major impetus over the last two decades. In this paper, we discuss the foundations which have helped in this paradigm shift from traditional Efficient Market Hypothesis (EMH) to the more experimental branch of finance, namely behavioural finance. We discuss EMH in the context of its critics, and present alternative theories as well as psychological concepts that are useful in understanding behavioural finance. We conduct 3 separate experiments to test Prospect theory, a popular theory put forth by Kahneman & Tversky [1]. We conduct the experiments on a different type of respondent group than that has been used in the past. Using a relatively homogenous group well versed in probability and statistics, we find that career professionals exhibit less biases than student subjects that have been used in such experiments in the past.