Stocks as Lotteries: The Implications of Probability Weighting for Security Prices

Nicholas Barberis and Ming Huang

American Economic Review, 2008, vol. 98, issue 5, 2066-2100

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. (JEL D81, G11, G12)

JEL-codes: D81 G11 G12 (search for similar items in EconPapers)
Date: 2008
Note: DOI: 10.1257/aer.98.5.2066
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Citations: View citations in EconPapers (523)

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Working Paper: Stocks as Lotteries: The Implications of Probability Weighting for Security Prices (2007)
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