Dollar-Cost Averaging and Prospect Theory Investors: An Explanation for a Popular Investment Strategy

Abstract (via Dichtl, Drobetz @ Journal of Behavioral Finance)

Dollar-cost averaging requires investing equal amounts of an investment sum step-by-step in regular time intervals. Previous studies that assume expected utility investors were unable to explain the popularity of dollar-cost averaging. Statman [1995] argues that dollar-cost averaging is consistent with the positive framework of behavioral finance. We assume a prospect theory investor who implements a strategic asset allocation plan and has the choice to shift the portfolio immediately (comparable to a lump sum) or on a step-by-step basis (dollar-cost averaging). Our simulation results support Statman’s [1995] notion that dollar-cost averaging may not be rational but a perfectly normal behavior.

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08. March 2011 by Miguel Barbosa
Categories: Behavioral Economics, Curated Readings | Leave a comment

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