00Thaler_FM i-xxvi.qxd

Graham, B., and D. Dodd, 1934, Security Analysis, McGraw-Hill. Hansen, L. P., and R. Hodrick, 1980, Forward exchange rates as op ...

Chapter 7 PROSPECT THEORY AND ASSET PRICES Nicholas Barberis, Ming Huang, and Tano Santos 1 .Introduction For many years now, th ...

Our specification of this additional source of utility captures two ideas we think are important for understanding investor beha ...

in the data. In our framework, changes in risk aversion are driven by past stock market movements and hence ultimately by news a ...

prospect theory into a formal pricing model may help us understand the level of average returns. While our work confirms this, w ...

Up to this point, our framework is entirely standard. We depart from the usual setup in the way we model investor preferences. I ...

today. This is a departure from traditional approaches, which hold that the only thing people think about when choosing a portfo ...

risk-free rate,StRf,t. In our example, and with a risk-free rate of say 5 per- cent, this means a reference level of 105. An end ...

specific stock price at salient moments in the past, such as the end of a year. Whichever way the benchmark level is formed, the ...

of the stock one year ago, which the investor still remembers. The differ- ence St−Zt=$10 represents the cushion, or reserve of ...

Note that if the loss is small enough to be completely cushioned by the prior gain—in other words, if StRt+ 1 >Zt, or equival ...

has no prior gains or losses, equations (3) and (4) show that we measure the pain of this loss as (90−100)(λ)=(90−100)(2)=−20. I ...

level of the stock market? If the return on the stock market is particularly good, investors should feel as though they have inc ...

sluggishly, allowing past gains and losses to linger and affect the investor for a long time; in other words, the investor has a ...

It is similar to v(Xt+ 1 , St, 1)—the middle line in figure 7.1—but is also mildly concave over gains and convex over losses. Th ...

The idea that prior outcomes may affect willingness to take risk is also supported by recent studies in psychology. Thaler and J ...

means that you make the decision about whether to take the gamble by comparing the average of w(−1200) and w(−800) with w(−1000) ...

and where for zt≤1, (15) and for zt>1, (16) with λ(zt)=λ+k(zt−1). (17) Equations (15) and (16) are pictured in figure 7.1. Fi ...

between our approach and the consumption-based framework then be- comes much clearer. In both economies, we construct a one-fact ...

Proposition 1.For the preferences given in (13)–(18), there exists an equilibrium in which the gross risk-free interest rate is ...