American Economic Review Vol. 98 No. 5 2008
Stocks as Lotteries: The Implications of Probability Weighting for Security Prices
open access
Abstract
We study the asset pricing implications of Tversky and Kahneman's (1992) cumulative prospect theory, with a particular focus on its probability weighting component. Our main result, derived from a novel equilibrium with nonunique global optima, is that, in contrast to the prediction of a standard expected utility model, a security's own skewness can be priced: a positively skewed security can be “overpriced” and can earn a negative average excess return. We argue that our analysis offers a unifying way of thinking about a number of seemingly unrelated financial phenomena.
- DOI
- 10.1257/aer.98.5.2066
- Volume
- 98
- Issue
- 5
- Pages
- 2066-2100
- Language
- en
- Sources
- openalex bibtex:phds-export.bib crossref