CFA Level I · CFA Level I Exam · The Behavioral Biases of Individuals
An analyst notes that investors in a market commonly hold losing positions too long while selling winners early, contradicting the predictions of expected utility theory. This observation is best described as supporting:
The pattern, holding losers and selling winners, supports prospect theory, which says people judge outcomes as gains or losses from a reference point and dislike losses more. Strong-form efficiency and CAPM's rational risk aversion assumptions would not predict this behavior.
- Athe efficient market hypothesis in its strong form
- Bprospect theory, which describes decisions relative to reference pointsCorrect
- Cthe capital asset pricing model's assumption of rational risk aversion
Explanation
Prospect theory holds that people evaluate outcomes as gains and losses relative to a reference point and feel losses more strongly, producing the disposition effect. Strong-form efficiency and CAPM rationality would not predict this pattern.
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