Prospect Theory and Liquidation Decisions

30 Pages Posted: 19 May 2005

See all articles by Albert S. Kyle

Albert S. Kyle

University of Maryland

Hui Ou-Yang

Cheung Kong Graduate School of Business

Wei Xiong

Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: February 8, 2005

Abstract

We solve a liquidation problem for an agent with preferences consistent with the prospect theory of Kahneman and Tversky (1978). We find that the agent is willing to hold a risky project with a relatively inferior Sharpe ratio if the project is currently making losses, and intends to liquidate it when it breaks even. On the other hand, the agent may liquidate a project with a relatively superior Sharpe ratio if its current profits rise or drop to the break-even point. Our results capture the spirit of the disposition effect and the break-even effect documented in empirical and experimental studies.

Keywords: Loss aversion, disposition effect; break-even effect

JEL Classification: G39, G19, D81

Suggested Citation

Kyle, Albert (Pete) S. and Ou-Yang, Hui and Xiong, Wei, Prospect Theory and Liquidation Decisions (February 8, 2005). Available at SSRN: https://ssrn.com/abstract=724402 or http://dx.doi.org/10.2139/ssrn.724402

Albert (Pete) S. Kyle

University of Maryland ( email )

College Park
College Park, MD 20742
United States

Hui Ou-Yang

Cheung Kong Graduate School of Business ( email )

Hong Kong
China
852-5199-6227 (Phone)

Wei Xiong (Contact Author)

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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