Parameter-free measurement of the utility function and loss aversion under prospect theory.

Summary In this work, the utility functions of portfolio managers are elicited and their degrees of loss aversion measured under the hypothesis of prospect theory (1992) and following the non-parametric method of Abdellaoui et al. The results obtained in the field corroborate the results obtained by the latter in the laboratory regarding the concavity of the utility function for gains and the convexity for losses. Regarding loss aversion, our observations confirm its existence. nevertheless, the median portfolio manager is less loss averse than the median student. Conditions that characterize real market experience but are difficult to reproduce in the artificial context of the laboratory could explain the differences in behavior: in particular, the volatility of the stock market, the incentive compensations of Wall Street and the fact that portfolio managers acquire a range of training and a high level of knowledge in the field that make them evaluate the stakes differently from students. The utility function must, however, reflect the preferences of the individual and the utility must not change depending on the method used. Indeed, the qualitative study of MBA students' preferences using the non-parametric method of Baucells and Heukamp (2006) confirms the results of Abdellaoui et al. It should be noted, however, that students change their preference (from loss averse to gain seeking) when one of the two lotteries offers a higher overall probability of gain or a higher probability of maximum gain combined with a limited extreme loss.