New concept for the value function of prospect theory

Kazuo Sano; Kazuo Sano

doi:10.3934/QFE.2024028

Quantitative Finance and Economics

2024, Volume 8, Issue 4: 733-756. doi: 10.3934/QFE.2024028

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Research article

New concept for the value function of prospect theory

Kazuo Sano ^,

SOBIN Institute LLC, 3-38-7 Keyakizaka, Kawanishi, Hyogo, 666-0145, Japan

Received: 15 August 2024 Revised: 24 October 2024 Accepted: 12 November 2024 Published: 14 November 2024
JEL Codes: G10, G17, G40, G41

In prospect theory, the value function is typically concave for gains and convex for losses, with losses usually having a steeper slope than gains. The neural system responds differently to losses and gains. Five new studies on neurons related to this issue have examined neuronal responses to losses, gains, and reference points. This study investigated a new concept of the value function. A value function with a neuronal cusp may exhibit variations and behavioral cusps associated with catastrophic events, potentially influencing a trader's decision to close a position. Additionally, we have conducted empirical studies on algorithmic trading strategies that employ different value function specifications.
- anterior cingulate cortex (ACC),
- lateral habenula (LHb),
- orbitofrontal cortex (OFC),
- dorsal striatum (DS),
- ventral striatum (VS),
- anterior insular cortex (AIC)
Citation: Kazuo Sano. New concept for the value function of prospect theory[J]. Quantitative Finance and Economics, 2024, 8(4): 733-756. doi: 10.3934/QFE.2024028

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Abstract

In prospect theory, the value function is typically concave for gains and convex for losses, with losses usually having a steeper slope than gains. The neural system responds differently to losses and gains. Five new studies on neurons related to this issue have examined neuronal responses to losses, gains, and reference points. This study investigated a new concept of the value function. A value function with a neuronal cusp may exhibit variations and behavioral cusps associated with catastrophic events, potentially influencing a trader's decision to close a position. Additionally, we have conducted empirical studies on algorithmic trading strategies that employ different value function specifications.

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