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Asset Prices Under Prospect Theory and Habit Formation

Asset Prices Under Prospect Theory and Habit Formation In this paper, we develop a consumption-based asset pricing model motivated by prospect theory, where habit formation determines the endogenous reference point. This exploits the similarity between habit formation and prospect theory. Both emphasize that the investor does not care about the absolute amount of gain or loss, but rather compares the gain or the loss experienced to a benchmark. The results show that when taking people's loss averse attitude over consumption into consideration, our model is capable of resolving the equity premium puzzle. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Pacific Basin Financial Markets and Policies World Scientific Publishing Company

Asset Prices Under Prospect Theory and Habit Formation

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References (31)

Publisher
World Scientific Publishing Company
Copyright
Copyright ©
ISSN
0219-0915
eISSN
1793-6705
DOI
10.1142/S0219091505000324
Publisher site
See Article on Publisher Site

Abstract

In this paper, we develop a consumption-based asset pricing model motivated by prospect theory, where habit formation determines the endogenous reference point. This exploits the similarity between habit formation and prospect theory. Both emphasize that the investor does not care about the absolute amount of gain or loss, but rather compares the gain or the loss experienced to a benchmark. The results show that when taking people's loss averse attitude over consumption into consideration, our model is capable of resolving the equity premium puzzle.

Journal

Review of Pacific Basin Financial Markets and PoliciesWorld Scientific Publishing Company

Published: Mar 1, 2005

Keywords: Prospect theory habit formation loss aversion consumption-based asset pricing model

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