Relationship between prospect theory and motivation of investor

There is a prospect theory in finance which means “a theory that describes decisions between alternatives that involve risk”. This was the meaning which some websites use to describe prospect theory. In simpler words however prospect theory is decision making under risk. The alternatives out of which we have to decide about, one of our best possible alternative to choose are uncertain, we only know about the probabilities of uncertainty for example this alternative security is 25 percent risky or this one is 60 percent risky etc. Prospect theory directly addresses how these alternatives, which present at the moment are framed and evaluated in the decision making process.

Now we’ll come to the second part that is motivation of investor. To see how prospect theory will affect the motivation of investor we shall first have to see the type of investor. There are two types of investors. One type is related to “risk takers” and other is related to “risk averse” investors. These two terms are self-explanatory so we shall now see how the motivation level of these two types of investors is related to prospect theory.
If the investor is a risk taker then in the presence of many risky securities for the investment purposes, he would go for the risky one alternative.

 For him, the principle would be

“Higher the risk, Higher will be the rate of return”

For him the motivation level will be high, his decision making would be stable. On the other hand a risk averse investor, who avoids risk, will have a low motivation level, because from the ample alternatives available to invest, he may not select any one of them or the chance is that he may select the least risky alternative. That leads to low motivation level to invest.

When we talk about risk, we did not specify it by saying political risk, exchange rate risk in case of international investor or default risk, or the risk inherent in the investment.  At the macro level, in our country or at the micro level, in our organizations, where we urge to motivate investors, so that they come and invest, offering them other benefits and lowering the interest rates in case of investment securities may not be the only attraction for the investors to invest. It depends on the type of investor which affects the decision making and motivation of the investor

 to invest.

So which type of investor are you?