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Distinguishing Rationality and Bias in Prices: Implications from Judgments of Risk and Expected Return

In: Contemporary Challenges in Risk Management

Author

Listed:
  • Hersh Shefrin

Abstract

There is a gulf between what theory and practice tell us about how risk premiums reward investors for bearing risk. An elegant theory relates expected return to both mean-variance efficient portfolios and to the covariance between returns and a pricing kernel. However, this theory has not proved to be especially valuable in empirical work, where risk premiums are instead explained using simple factor models involving size and book-to-market equity (B/M), for which there is little theoretical justification.

Suggested Citation

  • Hersh Shefrin, 2014. "Distinguishing Rationality and Bias in Prices: Implications from Judgments of Risk and Expected Return," Palgrave Macmillan Books, in: Torben Juul Andersen (ed.), Contemporary Challenges in Risk Management, chapter 1, pages 7-49, Palgrave Macmillan.
    • Handle: RePEc:pal:palchp:978-1-137-44762-3_2
    DOI: 10.1057/9781137447623_2
    as

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