Asset pricing for the lottery-like security under probability weighting: Based on generalized Wang transform

Helen Hui Huang, Jianchun Sun and Shunming Zhang

The North American Journal of Economics and Finance, 2024, vol. 71, issue C

Abstract: We present a two-stage lottery model with the generalized Wang transform as a probability weighting function to formally derive investors’ demand for the lottery-like security. Probability overweight on higher expected payoffs accounts for investors’ overvaluation of the security with moderately lottery-like feature, raising the demand and driving up the price. Investors’ aggressive demand is enhanced by optimistic attitude segmented from probability weighting function and weakened by probability distortion towards extreme events if considering fundamental risks. Our model predicts overpricing in small securities with optimistic investors, and implies skewness pricing and “realized kurtosis puzzle”.

Keywords: Lottery-like security pricing; Two-stage lottery model; Probability weighting; The generalized wang transform; Optimal strategy (search for similar items in EconPapers)
JEL-codes: G02 G11 G12 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:71:y:2024:i:c:s1062940824000020

DOI: 10.1016/j.najef.2024.102078

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