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Prospect Theory in the Heterogeneous Agent Model

  • Jan Polach
  • Jiri Kukacka
Regular Article
  • 83 Downloads

Abstract

Using the Heterogeneous Agent Model framework, we incorporate an extension based on Prospect Theory into a popular agent-based asset pricing model. This extension covers the phenomenon of loss aversion manifested in risk aversion and asymmetric treatment of gains and losses. Using Monte Carlo methods, we investigate behavior and statistical properties of the extended model and assess how our extension is manifested in different strategies. We show that, on the one hand, the Prospect Theory extension keeps the essential underlying mechanics of the model intact, but on the other hand it considerably changes the model dynamics. Stability of the model is increased and fundamentalists may be able to survive in the market more easily. When only the fundamentalists are loss-averse, other strategies profit more.

Keywords

Heterogeneous Agent Model Prospect Theory Behavioral finance Stylized facts 

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Copyright information

© Springer-Verlag GmbH Germany, part of Springer Nature 2018

Authors and Affiliations

  1. 1.Moody’s Analytics UK LtdLondonUnited Kingdom
  2. 2.Institute of Economic Studies, Faculty of Social SciencesCharles UniversityPrague 1Czech Republic
  3. 3.Institute of Information Theory and Automation of the Czech Academy of SciencesPrague 8Czech Republic

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