The Optimal Design of Savings Plans for Prospect Theory Investors

Manfred Frühwirth, Georg Mikula

    Publication: Working/Discussion PaperWorking Paper/Preprint


    In this paper we derive the optimal growth rate of dynamic savings plans. In contrast to existing literature (e.g. Frühwirth (2007)) we are the first to take the perspective of a prospect theory investor. We analyze in what way the optimal growth rate depends on the drift rate, the volatility, the risk-free rate, the gain sensitivity, the loss sensitivity and the loss aversion coefficient. In addition, we can use our setting to evaluate the benefits of dollar cost averaging versus lump sum investments as is frequently done in existing literature using criteria/models other than the prospect theory. We extend the works of Leggio/Lien (2001), who also analyze dollar cost averaging from a prospect theory investor’s perspective, by using an ex ante approach, an investment horizon of 10 years instead of one year and by also evaluating the dynamic savings plan. For our simulations we use parameters corresponding to historical data from various countries to see if there are differences in the attractivity of dollar cost averaging among different countries.
    Original languageEnglish
    Publication statusPublished - 1 Apr 2008

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