Prospect Theory: Test on Framing and Loss Aversion Effects on Investors Decision-Making Process At the Nairobi Securities Exchange, Kenya

Abstract

Twenty years of experimental and empirical research has demonstrated that markets are not as efficient as perceived to be. Investors are not rational and risk preferences are stochastic. In addition to this, prospect theory criticized the standard expected utility hypothesis used to describe utility and investor performance preferences. Kahneman and Tversky in 1979 proposed a new framework to model the utility and risk preferences of investors. This study examined investment scenarios with individual investors indicating that the process of making investment decisions is based on the behavioral economics theory which uses the fundamental aspects of the prospect theory developed by Kahneman and Tversky. The study tested two items: firstly framing which modifies the investment decision depending on the perspective given to the problem and secondly loss aversion which refers to a scenario where greater utility is lost when losing x amount of money than the utility that is gained when obtaining the exact same amount. The study concluded that framing effects influenced the decisions made by individual investors and individual investors had their investment decisions affected by loss aversion.