American Economic Review
ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)
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