Question

Read the following quote from Peter Bernstein, a financial historian and author of “Against The Gods: The Remarkable Story of Risk”,

“ “You never get poor by taking a profit”. It would follow that cutting your losses is also a good idea, but investors hate to take losses, because, tax considerations aside, a loss taken is an acknowledgment of error. Loss-aversion combined with ego leads investors to gamble by clinging to their mistakes in the fond hope that someday the market will vindicate their judgment and make them whole.”

Please use 50-100 words to comment on the connection between the above quote and the prospect theory developed by Kahneman and Tversky.

Answer 1

According to the Prospect theory of Kahneman and Tversky, an investor places more weights on the percieved gains than the percieved losses means if two equal options are in front of a person in terms of potential gains or losses, the person will take the first option because of behavior of human beings.

The quote from Peter Bernstein, investors hate to take losses which implies the same thing as of prospect theory. People lacks in the activity where they have to take the responsibility for their wrong decisions and that's why they don't like losses and places more weight on gains than losses.