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Prospect Theory and Asset Prices

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  • Nicholas BARBERIS

    (University of Chicago)

  • Ming HUANG

    (Stanford University)

  • Tano SANTOS

    (University of Chicago)

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    Abstract

    We study asset prices in an economy where investors derive direct utility not only from consumption but also from fluctuations in the value of their financial wealth. They are loss averse over these fluctuations and the degree of loss aversion depends on their prior investment performance. We find that our framework can help explain the high mean, excess volatility and predictability of stock returns, as well as their low correlation with consumption growth. The design of our model is influenced by prospect theory and by experimental evidence on how prior outcomes affect risky choice.

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    File URL: http://www.swissfinanceinstitute.ch/rp16.pdf
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    Bibliographic Info

    Paper provided by International Center for Financial Asset Management and Engineering in its series FAME Research Paper Series with number rp16.

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    Date of creation: Sep 2000
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    Handle: RePEc:fam:rpseri:rp16

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    Cited by:
    1. Ait-Sahalia, Y. & Brandt, M.W., 2001. "Variable Selection for Portfolio Choice," Papers 34, Manitoba - Department of Economics.
    2. Pietro Veronesi, . "Belief-dependent Utilities, Aversion to State-Uncertainty and Asset Prices,”," CRSP working papers 529, Center for Research in Security Prices, Graduate School of Business, University of Chicago.

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