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The article ‘Prospect Theory and Asset Prices’ by Barberis, Huang & Santos (2001) discusses the asset prices in an economic situation where the investors obtain indirect utility two elements. These elements are consumption and fluctuations resulting from the financial wealth value. The researchers evaluate two economies to identify the data analyzed in the research. Ideally, the authors explore the loss averse associated with the variations that depend on prior investments of stakeholders. In addition, the article explains the low correlation between excess volatility, predictability of stock return and consumption growth. In addition, the writers deviate from previous thoughts that aggregate stock market behavior is only affected by consumer behavior. According to the text, there are models that can be used to explain the financial growth of investors without involving the users. In building a case for their argument, the researchers employed several business models to justify their hypothesis.
The study seeks to explain to scholars that investors derive direct utility from both consumption and changes in their financial wealth value. Previous studies have mainly focused on describing the consumption-based mode (Barberis, Huang & Santos, 2001). However, the article explores another important factor that indirectly affects the utility maximization function of investors. For this reason, the research problem identified hopes to explain how financial wealth fluctuations affect the investment decisions of investors. Additionally, the researchers have developed a model, which has been differentiated from the consumption-based theory developed by previous scholars.
In summary, the research objectives have been divided into two parts. First, the researchers seek to explain the theory of loss aversion, which states that investors care more about the reduction in their wealth than increases. Secondly, the study illustrates that the performance of previous investments affects the loss-averse behavior of investors (Barberis, Huang & Santos, 2001). The model developed by the researchers introduces loss aversion over the financial wealth changes. It also ensures that the performance of previous investments affects the degree of loss aversion.
The researchers have utilized established theories and assumption to support the validity of the study objectives. For example, recursive utility approach introduced by Zin and Epstein is related to the model developed in the article (Barberis, Huang & Santos, 2001). Hence, the recursive utility approach suggests that there is a moderate relationship between stock returns and consumption growth. Subsequently the developed model incorporates two main ideas that related to psychology.
The prospect theory developed by Kahneman and Tversky describes the decision-making process at individual levels of risks. This theory directly relates to the researchers’ argument that investors care about the financial wealth changes, and they are risk averse. The second idea that prior outcomes and returns on investments affects future risk taking behavior also relates to psychology literature. Benartzi and Thaler studied an investor’s single-period portfolio, and their findings indicate that investors are reluctant to invest in particular stocks because of loss aversion (Barberis, Huang & Santos, 2001).
Even though, the reviewed article does not state the type of research design that the researcher have utilized, it is evident that this is an explanatory research design. This view is because the researchers have used several theories to support their research goals (Babbie, 2013). The mathematical equations have been accompanied by lengthy explanations so that users of the research findings can understand the results clearly. In addition, the authors use simple elaborations and the wording and theories utilized have shown that the design is explanatory. Hence, the research design selected is the best suitable for this study.
In obtaining the data, the researchers chose the identical method for both economies evaluated. The major statistical method used in the article is the correlation. Ideally, the aim of research is to prove that there is a relationship between the changes in financial wealth of investors and their utility. There are also other techniques used to analyze the mathematical equations developed in the equations, and these include the mean, standard deviation, and Sharpe ratio (Babbie, 2013). These statistical techniques are employed to ensure that the margin of error in the results presented is minimal. The volatility of dividend growth has been made more accurate by calculating the mean of the returns indicated. For this reason, the importance of these statistical techniques is to ensure that results are valid and reliable.
Results and Conclusions
It is essential to note that most of the results are presented in the form of tables and graphs. This view enhances the ability of readers and other scholars to draw conclusions from the results. Parameter k has been utilized to explain how painful it is for investors to make losses continuously. Table 1 gives the parameter values of economy 1. This table also shows that additional losses cause investors to become more risk averse than previous situations. The second table gives the average loss values over a given period. In this table, risk aversion changes given the returns used a volatility higher than 3.79 per cent that is assumed for the values of dividend growth (Barberis, Huang & Santos, 2001).
In conclusion, asset prices are similar to the historical data in an economy where investors obtain direct utility from changes in wealth and consumption. The main finding of the researchers indicates that the return on assets have a higher mean, excessive volatility and can be predicted in time series. The only weak correlation is with consumption growth.
This article has clearly explained how financial wealth fluctuations affect investor’s behavior and utility in the markets. Even so, the authors have not clearly explained the importance of the study. Additionally, the research objectives have not been clearly stated. It is expected that such objectives should be outlined in point form and heading given. However, the text provides a complex paragraph that states the objectives. The authors have no explained the relevance of the data collected. Ideally, the mathematical equations employed have very complicated equations, and readers may get confused about the meaning of the abbreviations in the models. Additionally, the data gathered in the study are very complex, and it is hard to deduce considering that, there are many tables containing information. The writers conclude their research with a question on over fluctuation in portfolios. These questions might confuse the readers because it may have to identify the findings of the studies. Finally, most research conducted has recommendations. This article does not give any recommendations based on the research goal. For this reason, the authors might not have achieved the objectives.
Babbie, E. (2013). The Practice of Social Research. Belmont, CA: Wadsworth Cengage.
Barberis, N., Huang, M. & Santos, T. (2001). Prospect Theory and Asset Prices, Quarterly Journal of Economics, 116 (1), 1-53.
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