Working Paper: NBER ID: w27155
Authors: Nicholas C. Barberis; Lawrence J. Jin; Baolian Wang
Abstract: We present a new model of asset prices in which investors evaluate risk according to prospect theory and examine its ability to explain 23 prominent stock market anomalies. The model incorporates all the elements of prospect theory, takes account of investors’ prior gains and losses, and makes quantitative predictions about an asset’s average return based on empirical estimates of its volatility, skewness, and past capital gain. We find that the model is helpful for thinking about a majority of the 23 anomalies.
Keywords: Prospect Theory; Stock Market; Anomalies
JEL Codes: G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| asset volatility (G19) | required returns (G12) |
| return skewness (C46) | average returns (G12) |
| prior gains (G14) | return expectations (D84) |
| volatility (E32) | expected returns (G17) |
| skewness (C46) | expected returns (G17) |
| capital gain overhang (G31) | expected returns (G17) |