Ex-ante Valuation based on Prospect Theory

Fang, Yi and Niu, Hui and Lin, Yuen (2023): Ex-ante Valuation based on Prospect Theory.

Abstract

We propose a simple algorithm for the ex-ante valuation based on prospect theory. Our results reveal a strong and robust pricing effect associated with predicted values based on prospect theory (PV) in the US market, that is, higher ex-ante PV stocks associated with higher returns. Our findings indicate no equilibrium exists for ex-ante PV. Our evidence shows liquidity has a limited impact on the ex-ante PV effect, which is mainly on liquid stocks. In general, liquidity, equilibrium, and the limits of arbitrage are crucial to understanding the ex-ante PV effect.

• Item Type: MPRA Paper
• Language: English
• Keywords: ex-ante valuation; prospect theory; equilibrium; liquidity; crash; jackpot
• Subjects: G - Financial Economics > G0 - General > G02 - Behavioral Finance: Underlying Principles; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; G - Financial Economics > G1 - General Financial Markets > G14 - Information and Market Efficiency ; Event Studies ; Insider Trading; G - Financial Economics > G1 - General Financial Markets > G17 - Financial Forecasting and Simulation

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