CAPM Equilibria with Prospect Theory Preferences
26 Pages Posted: 21 Jul 2003 Last revised: 6 Aug 2012
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
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