CAPM Equilibria with Prospect Theory Preferences

De Giorgi, Enrico G.; Hens, Thorsten; Levy, Haim

doi:10.2139/ssrn.420184

CAPM Equilibria with Prospect Theory Preferences

26 Pages Posted: 21 Jul 2003 Last revised: 6 Aug 2012

See all articles by Enrico G. De Giorgi

Enrico G. De Giorgi

University of St. Gallen - SEPS: Economics and Political Sciences

Thorsten Hens

University of Zurich - Department of Banking and Finance; Norwegian School of Economics and Business Administration (NHH); Swiss Finance Institute

Haim Levy

Hebrew University of Jerusalem - Jerusalem School of Business Administration; Fordham University

Date Written: 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

Keywords: asset pricing, cumulative prospect theory, capital asset pricing model

JEL Classification: C62, D51, D52, G11, G12

Suggested Citation: Suggested Citation

De Giorgi, Enrico G. and Hens, Thorsten and Levy, Haim, CAPM Equilibria with Prospect Theory Preferences (August 30, 2011). Available at SSRN: https://ssrn.com/abstract=420184 or http://dx.doi.org/10.2139/ssrn.420184