Prospect theory and utility theory: a comparison and application in the Nairobi Securities Exchange

A Research project submitted in partial fulfillment of the requirements for the degree of Bachelor of Business Science in Actuarial Science at Strathmore UniversityThe rationality-based market equilibrium models in finance in general are weighted down by anomalies such that attempting to replicate these models directly without reinforcing the attributes of the social psychology that affects an investor's rationale is inaccurate. Harburgh (2003) affirms that these simplistic economic models are poor predictors of human behavior and that there is a need for more detailed studies of human behavior in the process of making investment decisions. This study involves the application of Behavioral Finance where investors are assumed to follow descriptive decision-making processes rather than nom1ative decision-making processes- meaning and that the investor is not just rational in their decision patterns, but is also susceptible to cognitive biases, is more loss averse and regret averse, has a defined risk attitude, has preferences and has imperfect self-control (Statman 1999)These additional aspects that affect the investor's financial decisions form the investor's value characteristics. This paper aims at investigating how these value characteristics affect the decisions made by investors as they invest in the NSE Stock Exchange in Kenya