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Behavioral Finance

Predicting the willingness to pay for investment products – An experimental study. Behavioral Finance. Carsten Erner Alexander Klos Thomas Langer. Finance Center Münster DIA Research Group University of Münster. 1 – Motivation. Idea. Advisory process for retail investors.

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Behavioral Finance

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  1. Predicting the willingness to pay for investment products – An experimental study Behavioral Finance Carsten Erner Alexander Klos Thomas Langer Finance Center Münster DIA Research Group University of Münster

  2. 1 – Motivation Idea • Advisory process for retail investors.  What kind of product suits what kind of investor? • Structured financial products: Large and dynamic market in Germany  Banks can offer tailor-made products.

  3. 2 – Research Questions Main Questions Theoretical • Do theoretical models predict the willingness to pay for such products?  Theoretical Value vs. Actual WTP • How good in predicting actual WTP is prospect theory compared to expected utility theory and “simple” questionnaires used by banks? Practical • How should banks construct such products?  earn premium • Are the “complex” elicitation procedures (e.g. prospect theory) feasible in a bank environment?

  4. 3 – Experimental Design Part I – Eliciting Preference Parameters Prospect Theory • Abdellaoui/Bleichrodt/Paraschiv (2007), MS: Parameter-free elicitation Expected Utility Theory • Holt/Laury (2002), AER: Choosing from low-risk and high-risk lotteries • Eckel/Engle-Warnick/Johnson (2005), WP: Adaptive approach to Holt/Laury “Theory-free” elicitation • WPHG-Questionnaire • SOEP-Questionnaire • Survey-Questions from Barsky et al. (1997), QJE

  5. 3 – Experimental Design Part II – Eliciting Willingness to Pay General Setup • 200 Participants • BDM-Mechanism for WTP • Incentive compatible payment • 9 investment products + underlying • Test questions

  6. 4 – First Results Preference Elicitation – Prospect Theory • Example: • Approximately linear (small amounts) • Loss aversion

  7. 4 – First Results WTPs Absolute WTP – Median Investor • Subjects are on average able to give reasonable WTPs. • Large variance. • Relations of WTP are in accordance to loss aversion (“Median-Investor” (Tversky/Kahneman (1992)). • High premium for downside protection(Protective Put) Relative WTP – Individual Investor • Regression of individual loss aversion coefficient and difference between Black&Scholes-Value and stated WTP: • flat to slightly negative slope • no influence on an individual level

  8. 5 – Conclusions Main Findings • Solely computer-based elicitation seems to be difficult • High number of dominance violations • How to conduct elicitation procedures outside the lab in daily banking business? • Loss Aversion does not seem to have the expected impact on anindividual level (only for the median investor). • Next research steps: • Compare PT-results to EUT-results • Analyses of different expectations (ambiguity aversion) • …

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