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Prospect Theory and Asset Prices

Author

Listed:
  • Nicholas BARBERIS

    (University of Chicago)

  • Ming HUANG

    (Stanford University)

  • Tano SANTOS

    (University of Chicago)

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.

Suggested Citation

  • Nicholas BARBERIS & Ming HUANG & Tano SANTOS, 2000. "Prospect Theory and Asset Prices," FAME Research Paper Series rp16, International Center for Financial Asset Management and Engineering.
  • Handle: RePEc:fam:rpseri:rp16
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    References listed on IDEAS

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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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