Prospect Theory and Asset Prices
Top Cited Papers
- 1 February 2001
- journal article
- Published by Oxford University Press (OUP) in The Quarterly Journal of Economics
- Vol. 116 (1) , 1-53
- https://doi.org/10.1162/003355301556310
Abstract
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.Keywords
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