Stocks as Lotteries: The Implications of Probability Weighting for Security Prices / Nicholas Barberis, Ming Huang.

Format:

Book

Author/Creator:

Barberis, Nicholas.

Contributor:

National Bureau of Economic Research.

Huang, Ming.

Series:

Working Paper Series (National Bureau of Economic Research) no. w12936.

NBER working paper series no. w12936

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

Stocks as Lotteries

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2007.

Summary:

We study the asset pricing implications of Tversky and Kahneman's (1992) cumulative prospect theory, with particular focus on its probability weighting component. Our main result, derived from a novel equilibrium with non-unique global optima, is that, in contrast to the prediction of a standard expected utility model, a security's own skewness can be priced: a positively skewed security can be "overpriced," and can earn a negative average excess return. Our results offer a unifying way of thinking about a number of seemingly unrelated financial phenomena, such as the low average return on IPOs, private equity, and distressed stocks; the diversification discount; the low valuation of certain equity stubs; the pricing of out-of-the-money options; and the lack of diversification in many household portfolios.

Notes:

Print version record

February 2007.