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Permanent URL to this publication: http://dx.doi.org/10.5167/uzh-43751

De Giorgi, Enrico; Hens, Thorsten; Rieger, Marc Oliver (2010). Financial Market Equilibria with Cumulative Prospect Theory. Journal of Mathematical Economics, 46(5):633-651.

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Abstract

The paper first shows that financial market equilibria need not to exist if agents possess cumulative prospect theory preferences with piecewise-power value functions. This is due to the boundary behavior of the cumulative prospect theory value function, which might cause an infinite short-selling problem. But even when a nonnegativity constraint on final wealth is added, non-existence can occur due to the non-convexity of CPT preferences, which might cause discontinuities in the agents' demand functions. This latter observation also implies that concavification arguments which has been used in portfolio allocation problems with CPT preferences do not apply to our general equilibrium setting with finite many agents. Existence of equilibria is established when non-negativity constraints on final wealth are imposed and there is a continuum of agents in the market. However, if the original prospect theory is used instead of cumulative prospect theory, then other discontinuity problems can cause non-existence of market equilibria even in this case.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
DDC:330 Economics
Date:20 September 2010
Deposited On:28 Jan 2011 12:56
Last Modified:20 Jul 2014 18:53
Publisher:Elsevier
ISSN:0304-4068
Publisher DOI:10.1016/j.jmateco.2010.06.001

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