Using mutual fund flows, we evaluate prospect theory with choice outcomes in the market. We provide strong support for prospect theory: under a standard set of parameters, funds whose past returns generate higher prospect theory value attract significantly larger future flows; we also find corroborative evidence using account-level data. Taking a revealed preference approach, we estimate the prospect theory parameters through a discrete choice model and find that our field-based estimates align well with previous experiment-based estimates. Moreover, we show that prospect theory offers a new framework for understanding flows, as it has explanatory power beyond existing drivers.

We examine how stakes affect investor behaviors. In our unique setting, investors trade stocks in real accounts using their own money and simultaneously in a simulated setting. Our real-world within-investor estimation shows that investors exhibit stronger biases and perform worse in higher-stakes real accounts than in lower-stakes simulated accounts. Investors exhibit strong biases in both types of accounts, and the biases in both are strongly positively correlated. Such behavioral consistency suggests that low-stakes experiments are informative about real-world behaviors. Using additional account-level datasets, we demonstrate external validity by documenting a stronger (reverse) disposition effect on stocks (funds) with greater portfolio weights.

We present a new model of asset prices in which a representative agent has extrapolative beliefs about stock market returns and Epstein-Zin preferences. The model quantitatively explains facts about asset prices, return expectations, and cash-flow expectations. When the agent’s beliefs about stock market returns are calibrated to survey expectations of investors, the model generates excess volatility and predictability of stock market returns, a high equity premium, a low and stable risk-free rate, and a low correlation between stock market returns and consumption growth. Moreover, the model has implications for expectations about future cash flows that are consistent with empirical findings.