Probability Distortions, Collectivism, and International Stock Prices

78 Pages Posted: 7 Jan 2021 Last revised: 10 Dec 2021

See all articles by Fabian Hollstein

Fabian Hollstein

Saarland University

Vulnet Sejdiu

Leibniz Universität Hannover

Date Written: November 25, 2020

Abstract

We introduce a novel composite probability distortion (CPD) score based on investors’ stock valuations derived from a pure-probability-weighting version of cumulative prospect theory and from salience theory. This measure is priced among all size groups in the cross-section of international stock returns: low-CPD-score stocks are underpriced while those with high scores appear overpriced. Individualism is the main driver of differences in the CPD premium across countries and U.S. states. Consistent with the substantially lesser degree of probabilistic thinking in collectivist cultures documented by the psychology literature, we find that the CPD premium is substantially higher there than in individualist cultures.

Keywords: Collectivism, probability distortions, international stock returns, salience theory, cumulative prospect theory

JEL Classification: G40, G15, G12, Z10

Suggested Citation

Hollstein, Fabian and Sejdiu, Vulnet, Probability Distortions, Collectivism, and International Stock Prices (November 25, 2020). Available at SSRN: https://ssrn.com/abstract=3737342 or http://dx.doi.org/10.2139/ssrn.3737342

Fabian Hollstein (Contact Author)

Saarland University ( email )

Campus
Saarbrucken, Saarland D-66123
Germany

Vulnet Sejdiu

Leibniz Universität Hannover ( email )

Königsworther Platz 1
Hannover, 30167
Germany

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