Prospect Theory and the CAPM: A contradiction or coexistence?

Haim Levy, Enrico De Giorgi () and Thorsten Hens

No 157, IEW - Working Papers from Institute for Empirical Research in Economics - University of Zurich

Abstract: Under the assumption of normally distributed returns, we analyze whether the Cumulative Prospect Theory of Tversky and Kahneman (1992) is consistent with the Capital Asset Pricing Model. We find that in every financial market equilibrium the Security Market Line Theorem holds. However, under the specific functional form suggested by Tversky and Kahneman (1992) financial market equilibria do not exist. We suggest an alternative functional form that is consistent with both, the experimental results of Tversky and Kahneman and also with the existence of equilibria.

Keywords: Capital Asset Pricing Model; Prospect Theory (search for similar items in EconPapers)
JEL-codes: C62 D51 D52 G11 G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn and nep-fin
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Citations: View citations in EconPapers (11)

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