00Thaler_FM i-xxvi.qxd

The fundamental weakness of such a model comes in explaining volatility:
the standard deviations of returns in table 7.13 are much lower than both the
empirical value and the values in table 7.4. The reason for this failure is
straightforward. Since

(46)

the volatility of log returns in this model is equal to the volatility of log div-
idend growth, namely 12 percent. This problem is not unique to the model

R

PD

P

f

f

D

D

f

f

t tt e

t

t

t

t

t

gDDt

+

= +++ = + ++= + + +

1

111111 σ
(^1) ,
PROSPECT THEORY AND ASSET PRICES 263










































Figure 7.7. Stock prices and returns when prior outcomes have no effect. The price-
dividend ratio and the equity premium are plotted against b 0 , which controls how
much the investor cares about financial wealth fluctuations.
Table 7.12
Parameter Values for a Model Where Prior Outcomes Have No Effect
Parameter Section 6 Subsection 5.D
gC 1.84% 1.84%
gD 1.84% 1.84%
σC 3.79% 3.79%
σD 12.0% 12.0%
γ 1.0 1.0
ρ 0.98 0.98
λ 2.25 2.25
k — (range)
b 0 (range) (range)
η — 0.9
Parameter values used for Economy II in subsection 5.D are presented along-
side for comparison.