Testing dominant theories and assumptions in behavioral finance

Moawia Alghalith, Christos Floros, Marla Dukharan

    Research output: Contribution to journalArticlepeer-review


    Purpose – The purpose of this paper is to empirically test dominant theories and assumptions in behavioral finance, using data from the Standard & Poor's 500 index. Design/methodology/approach – The empirical analysis has three parts: to test the assumption of risk aversion; to examine the dominant theory that the optimal portfolio depends on risk preferences; and to test prospect theory that decision makers prefer certain outcomes over probable outcomes. Finally, an alternative model to test prospect theory is introduced. Findings – The proposed model is more flexible than prospect theory since it does not a priori assume what value of the portfolio induces risk aversion/seeking, while it does not a priori preclude linear preferences. Empirical results show that: investors are risk seeking; a change in the sign of preferences does not necessarily imply a change in the sign of wealth/return and vice versa; and the optimal portfolio does not depend on preferences. Practical implications – These findings are helpful to risk managers dealing with models of behavioural finance. Originality/value – The contribution of this paper is that it successfully tests fundamental theories and assumptions in behavioral finance by providing a better alternative to prospect theory in several ways.

    Original languageEnglish
    Pages (from-to)262-268
    Number of pages7
    JournalJournal of Risk Finance
    Issue number3
    Publication statusPublished - 18 May 2012


    • Behavioural economics
    • Dominant theory
    • Expectation
    • Financial forecasting
    • Investors
    • Prospect theory
    • Risk aversion
    • S&P500


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