Stocks as Lotteries: The Implications of Probability Weighting for Security Prices
Nicholas Barberis and Ming Huang
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| Article Citation |
Barberis, Nicholas, and Ming Huang. 2008. "Stocks as Lotteries: The Implications of Probability Weighting for Security Prices." American Economic Review, 98(5): 2066–2100.
DOI:10.1257/aer.98.5.2066
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| Abstract |
We study the asset pricing implications of Tversky and Kahneman's (1992)
cumulative prospect theory, with a particular focus on its probability weighting
component. Our main result, derived from a novel equilibrium with nonunique
global optima, is that, in contrast to the prediction of a standard expected utility
model, a security's own skewness can be priced: a positively skewed security
can be "overpriced" and can earn a negative average excess return. We argue
that our analysis offers a unifying way of thinking about a number of seemingly
unrelated financial phenomena. (JEL D81, G11, G12)
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| Article Full-Text Access |
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| Authors |
Barberis, Nicholas (Yale U)
Huang, Ming (Cornell U and Cheung Kong Graduate School of Business)
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| JEL Classifications |
D81: Criteria for Decision-Making under Risk and Uncertainty
G11: Portfolio Choice; Investment Decisions
G12: Asset Pricing; Trading volume; Bond Interest Rates
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