Dynamic portfolio choice and asset pricing with narrow framing and probability weighting
AbstractThis paper shows that the framework proposed by Barberis and Huang (2009) to incorporate narrow framing and loss aversion into dynamic models of portfolio choice and asset pricing can be extended to also account for probability weighting and for a value function that is convex on losses and concave on gains. We show that the addition of probability weighting and a convex–concave value function reinforces previous applications of narrow framing and cumulative prospect theory to understanding the stock market non-participation puzzle and the equity premium puzzle. Moreover, we show that a convex–concave value function generates new wealth effects that are consistent with empirical observations on stock market participation.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of Economic Dynamics and Control.
Volume (Year): 36 (2012)
Issue (Month): 7 ()
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Web page: http://www.elsevier.com/locate/jedc
Narrow framing; Cumulative prospect theory; Probability weighting function; Negative skewness; Dynamic programming;
Find related papers by JEL classification:
- D1 - Microeconomics - - Household Behavior
- D8 - Microeconomics - - Information, Knowledge, and Uncertainty
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
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