Probability distortion and non-participation

Lunyi Wang, Yao Wang and Shunming Zhang

Economics Letters, 2024, vol. 244, issue C

Abstract: This paper explores the impact of probability distortion on investors’ participation decisions and market performance. Specifically, we construct a one-period investment model with two types of investors—probabilistic pessimistic and neutral investors. The former assign more weight to bad outcomes and tail events when making decisions. Our findings suggest that non-participation arises from these probabilistic pessimistic investors. In equilibrium, their participation decisions affect the asset premium, which can be decomposed into the risk premium and probabilistic premium.

Keywords: Rank dependent utility; Probabilistic premium; Non-participation (search for similar items in EconPapers)
JEL-codes: D81 D84 G11 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecolet:v:244:y:2024:i:c:s0165176524004737

DOI: 10.1016/j.econlet.2024.111989

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