Stocks as Lotteries: The Implications of Probability Weighting for Security Prices
American Economic Review
vol. 98,
no. 5, December 2008
(pp. 2066-2100)
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)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.98.5.2066JEL Classification
- D81 Criteria for Decision-Making under Risk and Uncertainty
- G11 Portfolio Choice; Investment Decisions
- G12 Asset Pricing; Trading volume; Bond Interest Rates