Prospect Theory and Asset Prices
Coauthor(s): Nicholas Barberis, Ming Huang.
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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.
Source: Quarterly Journal of Economics
Barberis, Nicholas, Ming Huang, and Tano Santos. "Prospect Theory and Asset Prices." Quarterly Journal of Economics 116, no. 1 (February 2001): 1-53.