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Individual Preferences, Monetary Gambles and the Equity Premium

49 Pages Posted: 14 Oct 2003  

Nicholas Barberis

Yale School of Management; National Bureau of Economic Research (NBER)

Ming Huang

Cornell University - Samuel Curtis Johnson Graduate School of Management

Richard H. Thaler

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

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Date Written: September 2003

Abstract

We argue that narrow framing, whereby an agent who is offered a new gamble evaluates that gamble in isolation, separately from other risks she already faces, may be a more important feature of decision-making under risk than previously realized. To demonstrate this, we present evidence on typical attitudes to independent monetary gambles with both large and small stakes and show that across a wide range of utility functions, including all expected utility and many non-expected utility specifications, the only ones that can easily capture these attitudes are precisely those exhibiting narrow framing. Our analysis also makes predictions about the kinds of preferences that might be able to address the stock market participation and equity premium puzzles. We illustrate these predictions in simple portfolio choice and equilibrium settings.

Keywords: risk aversion, framing, loss aversion, stock market participation, equity premium

JEL Classification: D1, D8, G11, G12

Suggested Citation

Barberis, Nicholas and Huang, Ming and Thaler, Richard H., Individual Preferences, Monetary Gambles and the Equity Premium (September 2003). AFA 2004 San Diego Meetings. Available at SSRN: https://ssrn.com/abstract=446240 or http://dx.doi.org/10.2139/ssrn.446240

Nicholas Barberis (Contact Author)

Yale School of Management ( email )

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National Bureau of Economic Research (NBER)

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Ming Huang

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-225-9594 (Phone)

Richard Thaler

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-5208 (Phone)
773-702-0458 (Fax)

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