We examine a wide range of two-date economies populated by heterogeneous agents with the most common forms of nonexpected utility preferences used in finance and macroeconomics. We demonstrate that the risk premium and the risk-free rate in these models are sensitive to ignoring heterogeneity. This follows because of endogenous withdrawal by nonexpected utility agents from the market for the risky asset. This finding is important precisely because these alternative preferences have frequently been proposed as possible resolutions to various asset pricing puzzles, and they have all been examined exclusively in a representative agent framework.

We examine a wide range of two‐date economies populated by heterogeneous agents with the most common forms of nonexpected utility preferences used in finance and macroeconomics. We demonstrate that the risk premium and the risk‐free rate in these models are sensitive to ignoring heterogeneity. This follows because of endogenous withdrawal by nonexpected utility agents from the market for the risky asset. This finding is important precisely because these alternative preferences have frequently been proposed as possible resolutions to various asset pricing puzzles, and they have all been examined exclusively in a representative agent framework.

Despite their mediocre mean performance, actively managed mutual funds are distinct from passive funds in their return distributions. Active value funds better hedge downside risk, while active growth funds better capture upside potential. Since such performance features may appeal to investors with tail‐overweighting preferences, we show that preferences for downside protection and upside potential estimated from the empirical pricing kernel can help explain active fund flows in the value and growth categories, respectively. This effect of investor risk preferences varies significantly with funds' downside‐hedging and upside‐capturing ability, with levels of active management, and across retirement and retail funds.