Prospect Theory and Asset Prices
Abstract
We study asset prices in an economy where investors derive direct utility not only from consumption but also from fluctuations in the value of their financial wealth. They are loss averse over these fluctuations, and the degree of loss aversion depends on their prior investment performance. We find that our framework can help explain the high mean, excess volatility, and predictability of stock returns, as well as their low correlation with consumption growth. The design of our model is influenced by prospect theory and by experimental evidence on how prior outcomes affect risky choice.
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Behavioral-finance research identifies mechanisms and regularities that motivate interpretable operationalizations of risk response, experience, memory, and reference dependence.
“Behavioral-finance research identifies mechanisms and regularities that motivate interpretable operationalizations of risk response, experience, memory, and reference dependence (Tversky and Kahneman 1992;Barberis, Huang, and Santos 2001;Malmendier andNagel 2011, 2016;Bordalo, Gennaioli, and Shleifer 2020;Guiso, Sapienza, and Zingales 2018;Cohn et al. 2015).”
From FinPerMA: A Theory-Informed, Event-Grounded Personalized-Memory Benchmark for LLM Agents (2026) · cites this paper as Barberis, Huang, and Santos 2001
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References 88 · Cited by 1,895
- Authors
- Barberis, N., Huang, M., & Santos, T.
- Affiliations
- National Bureau of Economic Research (US)
- Stanford University (US)
- University of Chicago (US)
- Venue
- The Quarterly Journal of Economics
- Publisher
- Oxford University Press (OUP)
- Published
- 2001-02-01
- Volume
- 116
- Issue
- 1
- Pages
- 1-53
- ISSN
- 0033-5533 (ISSN-L)
- 1531-4650
- OpenAlex
- W3121252329
- Cited by
- 1,895
- References
- 88
- Citations by year
- 2026: 56 · 2025: 72 · 2024: 103 · 2023: 56 · 2022: 52 · 2021: 78 · 2020: 72 · 2019: 75 · 2018: 71 · 2017: 86 · 2016: 92 · 2015: 81 · 2014: 99 · 2013: 95 · 2012: 85
- FWCI
- 83.42
- Type
- journal article
- Language
- en
- Open access
- closed
- Locations
- The Quarterly Journal of Economics (publishedVersion)
- RePEc: Research Papers in Economics (submittedVersion)
- Topics
- Social Sciences › Economics, Econometrics and Finance › Finance › Financial Markets and Investment Strategies
- Social Sciences › Decision Sciences › General Decision Sciences › Decision-Making and Behavioral Economics
- Social Sciences › Economics, Econometrics and Finance › Economics and Econometrics › Economic theories and models
- Keywords
- prospect theory, asset prices, loss aversion, excess volatility, stock return predictability, consumption growth, decision making under risk
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