Prospect Theory and Stock Returns: A Seven Factor Pricing Model

Andros Gregoriou, Jerome Healy, Thi Thu Huong Le

Research output: Contribution to journalArticle

Abstract

The single-factor Capital Asset Pricing Model (CAPM), and its multi-factor extensions, are models that seek to explain investor's expectations for returns on risky assets. Empirical studies however, show that these factor models do not fully explain variations in expected returns. We show that a simple two factor model, based on the Peak-end rule (Fredrickson & Kahneman, 1993) from Prospect Theory (Kahneman & Tversky, 1979, 1992) explains variations in asset returns more thoroughly than the CAPM or it's extensions. Our results are derived from an extensive study on all US listed securities over the time period of 1927–2014. Based on our findings, we propose a Seven-Factor asset pricing model merging the insights of Expected Utility Theory, and Prospect Theory. Our new model explains variations in asset returns more comprehensively than the CAPM and its extensions including the recently established five factor CAPM by Fama and French (2015).

Original languageEnglish
Pages (from-to)315-322
Number of pages8
JournalJournal of Business Research
Volume101
DOIs
Publication statusPublished - 2 May 2019

Fingerprint

Factors
Capital asset pricing model
Stock returns
Prospect theory
Asset returns
Investors
Expected returns
Expected utility theory
Merging
Asset pricing models
Empirical study
Multi-factor
Assets

Keywords

  • Prospect theory
  • Peak-end rule
  • Cognitive bias
  • CAPM

Cite this

Gregoriou, Andros ; Healy, Jerome ; Le, Thi Thu Huong. / Prospect Theory and Stock Returns : A Seven Factor Pricing Model. In: Journal of Business Research. 2019 ; Vol. 101. pp. 315-322.
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Prospect Theory and Stock Returns : A Seven Factor Pricing Model. / Gregoriou, Andros; Healy, Jerome; Le, Thi Thu Huong.

In: Journal of Business Research, Vol. 101, 02.05.2019, p. 315-322.

Research output: Contribution to journalArticle

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