Publication: Inverse s-shaped probability weighting and its impact on investment
Issued Date
2018-01-01
Resource Type
ISSN
21568499
21568472
21568472
Other identifier(s)
2-s2.0-85056544128
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Mahidol University
Rights Holder(s)
SCOPUS
Bibliographic Citation
Mathematical Control and Related Fields. Vol.8, No.3-4 (2018), 679-706
Suggested Citation
Xue Dong He, Roy Kouwenberg, Xun Yu Zhou Inverse s-shaped probability weighting and its impact on investment. Mathematical Control and Related Fields. Vol.8, No.3-4 (2018), 679-706. doi:10.2139/ssrn.3067189 Retrieved from: https://repository.li.mahidol.ac.th/handle/20.500.14594/46112
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Title
Inverse s-shaped probability weighting and its impact on investment
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Abstract
© 2018, American Institute of Mathematical Sciences. All rights reserved. In this paper we analyze how changes in inverse S-shaped probability weighting influence optimal portfolio choice in a rank-dependent utility model. We derive sufficient conditions for the existence of an optimal solution of the investment problem, and then define the notion of a more inverse S-shaped probability weighting function. We show that an increase in inverse S-shaped weighting typically leads to a lower allocation to the risky asset, regardless of whether the return distribution is skewed left or right, as long as it offers a non-negligible risk premium. Only for lottery stocks with poor expected returns and extremely positive skewness does an increase in inverse S-shaped probability weighting lead to larger portfolio allocations.