Abstract
We present a model of an artificial financial economy, where a number of heterogenous agents, i.e., households, firms, and a commercial bank make endogenous financial decisions which involve portfolio investments for households, capital structure and dividends policy for firms, and lending and borrowing rates for the commercial bank. Labour income for households and earnings for firms are exogenous determined, according to two independent stochastic processes. Economic policy is set by a government which collects taxes and issues government bonds, and by a central bank which fixes the base interest rate. The purpose of the computational experiments presented in this paper is to focus the attention on a particular and very important aspect concerning the way households form their preferences. In order to include psychological traits in household decision making, Prospect Theory have inspired our study. Indeed, Prospect Theory is a well established framework with a rich theoretical and experimental literature. Computational experiments point out that prospect theory psychological assumptions influence many important financial processes, like assets prices formation and portfolio selection. In particular, loss aversion influences the financial market in a not trivial way. The main results of our study is the emergence of a clear relation between the evaluation period of the household and its portfolio composition in terms of the ratio between risky assets, i.e., stocks, and less risky assets, i.e., bonds. Finally, the model offers more elements to interpret the equity premium puzzle, clearly showing that the stocks-bonds ratio does not depend only from risk-aversion but also from households evaluation periods.
Keywords
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.
This is a preview of subscription content, log in via an institution.
Buying options
Tax calculation will be finalised at checkout
Purchases are for personal use only
Learn about institutional subscriptionsPreview
Unable to display preview. Download preview PDF.
References
N. Barberis, M. Huang, and T. Santos. Prospect theory and asset prices. Quarterly Journal of Economics, 116(1):1-53, 2001.
S. Benartzi and R. H. Thaler. Myopic loss aversion and the equity premium puzzle. The Quarterly Journal of Economics, 110(1):73-92, 1995.
A. Deaton. Household saving in ldcs: credit markets, insurance and welfare. The Scandinavian Journal of Economics, 94(2):253-273, 1992.
D. Kahneman and A. Tversky. Prospect theory: an analysis of decision under risk. Econometrica, 47(2):263-292, 1979.
R. Mehra and E. Prescott. The equity premium puzzle. Journal of Monetary Economics, XV:145-161,1985.
M. Raberto, A. Teglio, and S. Cincotti. Integrating real and financial markets in an agent-based economic model: an application to monetary policy design. Computational Economics, 2008, available online, DOI: 10.1007/s10614-008-9138-2.
R. H. Thaler. Towards a positive theory of consumer choice. Journal of Economic Behavior and Organization, 1:39-60, 1980.
J. Tirole. The Theory of Corporate Finance. Princeton University Press, Princeton, 2006.
A. Tversky and D. Kahneman. Advances in prospect theory: cumulative representation of uncertainty. Journal of Risk and Uncertainty, 5(4):297-323, 1992.
Author information
Authors and Affiliations
Editor information
Editors and Affiliations
Rights and permissions
Copyright information
© 2008 Springer-Verlag Berlin Heidelberg
About this chapter
Cite this chapter
Raberto, M., Teglio, A., Cincotti, S. (2008). Prospect Theory Behavioral Assumptions in an Artificial Financial Economy. In: Schredelseker, K., Hauser, F. (eds) Complexity and Artificial Markets. Lecture Notes in Economics and Mathematical Systems, vol 614. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-540-70556-7_5
Download citation
DOI: https://doi.org/10.1007/978-3-540-70556-7_5
Publisher Name: Springer, Berlin, Heidelberg
Print ISBN: 978-3-540-70553-6
Online ISBN: 978-3-540-70556-7
eBook Packages: Business and EconomicsEconomics and Finance (R0)