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CAPM Equilibria with Prospect Theory PreferencesEnrico G. De GiorgiUniversity of St. Gallen - SEPS: Economics and Political Sciences Thorsten HensDepartment of Banking and Finance; Norwegian School of Economics and Business Administration (NHH); Swiss Finance Institute (Zurich Center) Haim LevyHebrew University of Jerusalem - Jerusalem School of Business Administration August 30, 2011 Abstract: Under the assumption of normally distributed returns, we analyze whether the Cumulative Prospect Theory of Tversky and Kahneman (1992) is consistent with the Capital Asset Pricing Model. We find that in every financial market equilibrium, the Security Market Line Theorem holds. However, under the functional form for the utility index suggested by Tversky and Kahneman (1992), the conditions for existence of financial market equilibria exclude economically meaningful equilibria. We suggest an alternative functional form that is consistent with both, the experimental results of Tversky and Kahneman (1992), and also with the existence of economically meaningful equilibria
Number of Pages in PDF File: 26 Keywords: asset pricing, cumulative prospect theory, capital asset pricing model JEL Classification: C62, D51, D52, G11, G12 working papers seriesDate posted: July 21, 2003 ; Last revised: August 6, 2012Suggested CitationContact Information
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