Prospect theory and the risk-return paradox: some recent evidence

Prospect theory and the risk-return paradox: some recent evidence There is extensive evidence indicating a negative risk–return relation when a firm’s performance is measured based on accounting measures such as return on asset (ROA) and return on equity (ROE). Previous studies show that the risk-return paradox can be explained by the prospect theory, which predicts that managers’ risk attitudes are different for firms of different performances. However, those studies mostly use earlier data from the COMPUSTAT database, which suffers from a survivorship bias. Failure to account for delisting firms may understate the risk–return relation. We reexamine the mixture of risk-seeking and risk-averse behaviors based on an updated 20-year sample period that is free from the survivorship problem. Interestingly, our results show stronger and robust evidence supporting the prospect theory during the period from 1984 to 2003. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

Prospect theory and the risk-return paradox: some recent evidence

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Publisher
Springer US
Copyright
Copyright © 2009 by Springer Science+Business Media, LLC
Subject
Finance; Corporate Finance; Accounting/Auditing; Econometrics; Operation Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1007/s11156-009-0109-z
Publisher site
See Article on Publisher Site

Abstract

There is extensive evidence indicating a negative risk–return relation when a firm’s performance is measured based on accounting measures such as return on asset (ROA) and return on equity (ROE). Previous studies show that the risk-return paradox can be explained by the prospect theory, which predicts that managers’ risk attitudes are different for firms of different performances. However, those studies mostly use earlier data from the COMPUSTAT database, which suffers from a survivorship bias. Failure to account for delisting firms may understate the risk–return relation. We reexamine the mixture of risk-seeking and risk-averse behaviors based on an updated 20-year sample period that is free from the survivorship problem. Interestingly, our results show stronger and robust evidence supporting the prospect theory during the period from 1984 to 2003.

Journal

Review of Quantitative Finance and AccountingSpringer Journals

Published: Feb 24, 2009

References

  • Sample-dependent results using accounting and market
    Banz, RW; Breen, WJ
  • Industry costs of equity
    Fama, EF; French, KR
  • Another look at the cross-section of expected returns
    Kothari, SP; Shanken, J; Sloan, RG

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