← Search

Journal of Finance 2026

Reference‐Dependent Preferences and Sentiment‐Driven Asset Prices

Jess Benhabib1; ZHAORUI LI; Xuewen Liu; Pengfei Wang2,3

1 American Institute of Biological Sciences · 2 HSBC Holdings · 3 University of Hong Kong

open access

Abstract

This paper studies asset pricing under expectations‐based reference‐dependent preferences in a general equilibrium framework. We show that reference‐dependent preferences can generate self‐fulfilling risk panics, producing sentiment‐driven asset price fluctuations through a feedback loop between current prices and perceived future downside risk—dynamics impossible under standard expected utility. The model helps explain empirical puzzles including (i) excess volatility, (ii) asymmetric volatility, (iii) asymmetric sentiment over the business cycle, (iv) excess asset price comovement, and (v) weak correlations between stock returns and economic fundamentals, alongside a sizable equity premium. Additional empirical evidence based on closed‐end fund discounts and quantitative analysis support the theory.

DOI
10.1111/jofi.70079
Language
en
Sources
openalex crossref

Cite