Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/294932 
Year of Publication: 
2020
Citation: 
[Journal:] Junior Management Science (JUMS) [ISSN:] 2942-1861 [Volume:] 5 [Issue:] 3 [Year:] 2020 [Pages:] 262-294
Publisher: 
Junior Management Science e. V., Planegg
Abstract: 
I test the hypothesis that investors evaluate stocks based on the prospect theory value of the distribution of past returns. Because some investors tilt towards stocks with high prospect theory value, these stocks become overvalued and earn low subsequent returns. During bubbles this effect should be stronger, due to rising limits to arbitrage and increased participation of individual investors. I do not find strong support for this prediction in the cross section of returns in U.S. stock markets. In contrast to other variables know to explain returns however, prospect theory value does not lose its predictive power during bubbles. Investors with prospect theory preferences seem to choose stocks whose returns optimally combine low standard deviation with high skewness.
Subjects: 
Prospect Theory
bubbles
limits to arbitrage
individual investors
Persistent Identifier of the first edition: 
Creative Commons License: 
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Document Type: 
Article
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