As I experienced behavioural finance is not all about heuristics and biases. The book of Thorsten Hens contains many mathematical functions and solutions which exceed my knowledge. Anyway I could profit on some mathematical and especially on logical issues.
Below you find a picture of the prospect theory value function of kahneman and tversky. It delivers the reason why people limit wins and let losses run deeper and deeper. Furthermore it gives a reason to the loss aversion of people who consider a 5% loss more severe than a 5% win.
Regarding the behaviour of this prototyp behavioural investor, Hens delivers an example with which one can examine if the client is an expected utility invetor or an investor according to the prospect theory.
You posses two credit cards and two wallets. The chance of losing one wallet is 25% and this 25% is independent of losing the second wallet. Which investor will decide to diversify the cards and which investor will put both cards in one wallet?
Solution: Daniel Kahneman will put both credit cards into the same wallet in order to minimize the chance of losing one of the cards. Whereas Daniel Bernoulli (founder of the expected utility theory) will diversify his cards into each wallet.
