Prospect Theory and Rational Theory

Question :

Using theories like : Prospect theory, Rational behavior and Earning response Coefficient. Plz, Choose 2 out 3 to explain about a provided article.

Answer :

Prospect theory and Rational theory

Prospect theory helps in understanding about the decision making behavior of individuals at the time of risk and uncertainty (Kahneman & Tversky, 2013). It states that the decisons are made by individuals after considering the perceived losses and gains instead of actual final outcome. Here, the case of Aurora Cannabis can be taken. In the first week of Feburary this year the company showed loss of around C$1 billion due to goodwill and asset impairment charges. In this, around C$750 will be written off in goodwill and around C$200 in intangible charges (Cherney, 2020). After coming of the earnings reports, there has been negative responses from trade analysts. The investors are seeing potential loss while staying invested in the company and thus they got out of this and the share of the company tanked sharply. The action of the company is merely a shake off to correct things, but investors are seeing negative potential.

Rational behaviour theory states that the individuals make decisions that bring optimal benefit or utility (Elton et al, 2011). And when someone thinks being a third party in the situation, they often think rationally. As it can be seen in the case of Aurora Cannabis. Market has shown negative stance on the company, but most analysts are positive on it. Out of 19 analysts, 11 stated to hold the stock instead of getting out of it. It has been expected that the price will rise to $2.08 bringing in 33%. This ws forecasted a month and half ago. The current market shows $1.48 stock price and the stock has somewhat moved up in the past five days.

References

Cherney, M. (2020). Aurora Cannabis earnings: Here comes a billion-dollar loss. Retrieved 15 March 2020, from https://www.marketwatch.com/story/aurora-cannabis-earnings-here-comes-a-billion-dollar-loss-2020-02-11

Elton, E. J., Gruber, M. J., & Busse, J. A. (2011). Are investors rational? Choices among index funds. In Investments And Portfolio Performance (pp. 145-172).

Kahneman, D., & Tversky, A. (2013). Prospect theory: An analysis of decision under risk. In Handbook of the fundamentals of financial decision making: Part I (pp. 99-127).