Prospect Theory and Stock Returns: An Empirical Test

Nicholas Barberis, Abhiroop Mukherjee and Baolian Wang

The Review of Financial Studies, 2016, vol. 29, issue 11, 3068-3107

Abstract: We test the hypothesis that, when thinking about allocating money to a stock, investors mentally represent the stock by the distribution of its past returns and then evaluate this distribution in the way described by prospect theory. In a simple model of asset prices in which some investors think in this way, a stock whose past return distribution has a high (low) prospect theory value earns a low (high) subsequent return, on average. We find empirical support for this prediction in the cross-section of stock returns in the U.S. market, and also in a majority of forty-six other national stock markets. (JEL D03)Received November 19, 2014; accepted May 20, 2016, by Editor Stefan Nagel.

JEL-codes: D03 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (121)

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