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Probability distortion and non-participation

Author

Listed:
  • Wang, Lunyi
  • Wang, Yao
  • Zhang, Shunming

Abstract

This paper explores the impact of probability distortion on investors’ participation decisions and market performance. Specifically, we construct a one-period investment model with two types of investors—probabilistic pessimistic and neutral investors. The former assign more weight to bad outcomes and tail events when making decisions. Our findings suggest that non-participation arises from these probabilistic pessimistic investors. In equilibrium, their participation decisions affect the asset premium, which can be decomposed into the risk premium and probabilistic premium.

Suggested Citation

  • Wang, Lunyi & Wang, Yao & Zhang, Shunming, 2024. "Probability distortion and non-participation," Economics Letters, Elsevier, vol. 244(C).
    • Handle: RePEc:eee:ecolet:v:244:y:2024:i:c:s0165176524004737
    DOI: 10.1016/j.econlet.2024.111989
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    References listed on IDEAS

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    9. Stephen G Dimmock & Roy Kouwenberg & Olivia S Mitchell & Kim Peijnenburg, 2021. "Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field," The Review of Financial Studies, Society for Financial Studies, vol. 34(9), pages 4524-4563.
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    More about this item

    Keywords

    Rank dependent utility; Probabilistic premium; Non-participation;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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