Dynamic portfolio choice and asset pricing with narrow framing and probability weighting

Enrico De Giorgi () and Shane Legg

Journal of Economic Dynamics and Control, 2012, vol. 36, issue 7, 951-972

Abstract: This paper shows that the framework proposed by Barberis and Huang (2009) to incorporate narrow framing and loss aversion into dynamic models of portfolio choice and asset pricing can be extended to also account for probability weighting and for a value function that is convex on losses and concave on gains. We show that the addition of probability weighting and a convex–concave value function reinforces previous applications of narrow framing and cumulative prospect theory to understanding the stock market non-participation puzzle and the equity premium puzzle. Moreover, we show that a convex–concave value function generates new wealth effects that are consistent with empirical observations on stock market participation.

Keywords: Narrow framing; Cumulative prospect theory; Probability weighting function; Negative skewness; Dynamic programming (search for similar items in EconPapers)
JEL-codes: D1 D8 G11 G12 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (34)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:36:y:2012:i:7:p:951-972

DOI: 10.1016/j.jedc.2012.01.010

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