PROSPECT THEORY AND INVESTORS TRADING BEHAVIOUR MARKET. Philip Brown Gary Smith * Kate Wilkie. Abstract

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1 PROSPECT THEORY AND INVESTORS TRADING BEHAVIOUR IN THE AUSTRALIAN STOCK MARKET by Philip Brown Gary Smith * Kate Wilkie Abstract What, apart from taxation incentives and information arrival, explains inter-temporal change in market liquidity? We address this question from the perspective of prospect theory, which proposes that individuals are risk averse in the domain of gains and risk seeking in losses. We find that Australian investors prefer to realise gains earlier than losses and that in so doing their behaviour is more consistent with prospect theory than with alternative explanations arising from the taxation regime or from the traditional paradigm of rational choice. Key Words : Behavioural Finance, Prospect Theory, Market Liquidity, Australian Stock Market. JEL Classification : D81 *All of the University of Western Australia. Please address all correspondence to Gary Smith, Department of Accounting and Finance, The University of WA, 35 Stirling Highway, Crawley, WA, 6009; Gary.Smith@uwa.edu.au ; Phone ; Fax The authors would like to acknowledge the invaluable programming assistance of Ms Jennifer Cross.

2 PROSPECT THEORY AND INVESTORS TRADING BEHAVIOUR IN THE AUSTRALIAN STOCK MARKET

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