1. PROSPECT THEORY AND ASSET PRICES 小组成员 王 莹 王殿武 邢天怡

2. PROSPECT THEORY AND ASSET PRICES  I. Introduction  II. Investor preferences  III. Evidence from psychologyrences  IV. Equilibrium prices  V. Numerical results and further discussion  VI. The importance of prior outcomes  VII. Conclusion

3. Our model VS The consumption-based model(1)  Utility from consumption  Utility from fluctuations in the value of their financial wealth INTRODUCTION

4. INTRODUCTION Our model VS The consumption-based model(2)  High historical average return  Significant volatility  Predictability  low correlation with consumption growth

5. INVESTOR PREFERENCES 1.a continuum of identical infinitely lived agents 2.two assets: a risk-free asset one unit of a risky asset 3.The dividend sequence

6. Utility function INVESTOR PREFERENCES

7. A.Measuring Gains and Losses Measure period:1year INVESTOR PREFERENCES

8. B. Tracking Prior Investment Outcomes for St - Zt,  When St > Zt, the investor has had prior gains.  when St < Zt, the investor has endured prior losses. Set INVESTOR PREFERENCES -

9. C. Utility from Gains and Losses for INVESTOR PREFERENCES =1

10. The case of Zt = 1 The case of Zt < 1

11. In summary For

12. The case of Zt > 1 Zt=1 (90 - 100)( ) = (90 - 100)(2) = -20 Zt=1.1 (90 - 100)( + 3(0.1)) = (90 - 100)(2 + 3(0.1)) = -23

13. D. Dynamics of the Benchmark Level two ways to change the value of the investor's stock holdings take out the dividend and consume it, or he may buy or sell some shares through its return between time t and time t + 1 INVESTOR PREFERENCES

14. through its return between time t and time t + 1 To allow for varying degrees of sluggishness in the dynamics of the historical benchmark level

15. E. The Scaling Term bt INVESTOR PREFERENCES

16. EVIDENCE FROM PSYCHOLOGY Kahneman and Tversky [1979]

17. Thaler and Johnson [1990] outcomes in earlier gambles affect subsequent behavior: following a gain, people appear to be more risk seeking than usual, taking on bets they would not normally accept. people are less risk aversefollowing prior gains and more risk averse after prior losses

18. Ⅳ.Equilibrium Prices ρ : ρ is the time discount factor γ : γ>0 controls the curvature of utility over consumption :is an exogenous scaling factor :is the gain or loss the agent experiences on his financial investments between time t and t+1 :a state variable which measures the investor’s gains or losses prior to time t as a fraction of :the utility the investor receives from this gain or loss : the risk-free rate :η can be given an interpretation in terms of the investor’s memory η :is a fixed parameter

20. The dynamics of the state variable are given by Economy Ⅰ equates consumption and dividends so that stocks are modeled as a claim to the future consumption stream. Economy Ⅱ - where consumption and dividends are modeled as separate processes. We can then allow the volatility of consumption growth and of dividend growth to be very different, as they indeed are in the data. We assume that the price-dividend ratio of the stock is a function of the state variable : Given the one-factor assumption, the distribution of stock return is determined by and the function using

21. A. Stock Prices in Economy Ⅰ, is aggregate consumption According to (20), Past gains make the investor less risk averse, raising ƒ, while past losses make him more risk averse, lowering ƒ.

22. Euler equation:

23. B. Stock Prices in Economy Ⅱ We assume:

24. C. Model Intuition Our model is consistent with a low volatility of consumption growth on the one hand, and a high mean and volatility of stock returns on the other, while maintaining a low and stable risk-free rate. Moreover, it generates long horizon predictability in stock returns similar to that observed in empirical studies and predicts a low correlation between consumption growth and stock returns.

25. It may be helpful to outline the intuition behind these results before moving to the simulations. 1.Return volatility is a good place to start: how can our model generate returns that are more volatile than the underlying dividends? 2.The same mechanism also produces long horizon predictability. 3.If changing loss aversion can indeed generate volatile stock prices, then we may also be able to generate a substantial equity premium. 4.Finally, our framework also generates stock returns that are only weakly correlated with consumption, as in the data. 5.Another well-known difficulty with consumption-based models is that attempts to make them match features of the stock market often lead to counterfactual predictions for the risk-free rate.

26. D.A Note on Aggregation The equilibrium pricing equations in subsections IV.A and IV.B are derived under the assumption that the investors in our economy are completely homogeneous. This is certainly a strong assumption. Investors may be heterogeneous along numerous dimensions, which raises the question of whether the intuition of our model still goes through once investor heterogeneity is recognized. For any particular form of heterogeneity, we need to check that loss aversion remains in the aggregate and, moreover, that aggregate loss aversion still varies with prior stock market movements. If these two elements are still present, our model should still be able to generate a high premium, volatility, and predictability.

27. The investor chooses consumption and an allocation to the risky asset to maximize

34. Ⅴ. NUMERICAL RESULTS & FURTHER DISCUSSION Solve f(Z t ) of equations (24) and (34) 。 create a long time series of simulated data and use it to compute various moments of asset returns.We do this for both economies A. Parameter Values g c : the mean of log consumption growth σ c : the standard deviation of log consumption growth γ : the curvature ρ : the time discount factor λ : how keenly losses k: how much more painful losses are we pick k in two different ways b 0 : the relative importance of the prospect utility term in the investor's preferences η : the state variable dynamics The investor's preference parameters

35. average loss aversion Zt < 1 ： when the investor has prior gains-part of any subsequent loss is penalized at a rate of one, and part of it is penalized at a rate of2.25. Zt ≥ 1 ： 2.25 for Zt = 1, and higher than 2.25 for Zt > 1. When Zt ≤ 1: the expected loss aversion when the excess stock return is distributed as We compute the quantity λ for which an investor with utility function

36. B. Methodology The difficulty in solving equation (24) comes from the fact that Z t+l is a function of both E t+l andf(·). (35) (36) f (0 ) h (0) f (1) h= h (1) f (i) → f, h (i) → hz t+1 =h (0) (z t, t+1 ) ，.

37. C. Stock Prices in Economy Ⅰ K=3 f(Zt) is a decreasing function of Zt in all cases. does not tell us the range of price-dividend ratios

38. we draw a long time series of 50,000 independent draws from the standard normal distribution. Zo = 1 Z t+l = h(z t, Et+l) The value of R in equation (10) is chosen precisely to make the median value of Zt as close to one as possible.

39. Changes in risk aversion :higher than the 3.79 percent volatility. The highest equity premium : this value of k is 1.28 percent. The bottom panel of Table II :we can come closer to matching the historical equity premium by increasing the value of k.

40. D. Stock Prices in Economy Ⅱ g D ： the mean dividend growth rate; σ D :the volatility of dividend growth; w:The correlation of shocks to dividend growth and consumption growth. Using NYSE data from 1926-1995 from CRSP ， σ D =0.12

41. The volatility of returns is now much higher than what we obtained in Economy I dividend growth volatility is now 12 percent rather than just 3.79 percent.

42. Campbell and Cochrane The investor cares not only about consumption but also about fluctuations in the value of his investments. Stocks are now less correlated with consumption stock returns are only weakly correlated with consumption growth

43. We report the mean and standard deviation of the simulated price-dividend ratio. It is striking that while we are matching the volatility of returns, we significantly underpredict the volatility of the price-dividend ratio. Campbell, Lo, and MacKinlay[1997] ｒ t+1 ≈A+logƒ t+1 -logƒ t + σ D t+1 Var( ｒ t+1 )≈var(log)+ +2cov(log, σ D t+1 ) var(log( f t+1 1ft) too low cov(log, σ D t+1 ) is too high Changes in price-dividend ratios are perfectly conditionally correlated with dividend shocks. consumption relative to habit is one possible factor suggested by the habit formation literature.

44. Left : Low values of Zt mean that the investor has accumulated prior gains that will cushion future losses. Right : the conditional volatility of returns as a function of the state variable. the conditional volatility in any state depends on how sensitive the investor's risk aversion in that state is to dividend shocks.

45. Negatively autocorrelated returns at all lags Poterba and Summers [1988] and Fama and French[1988a] the price-dividend ratio is highly autocorrelated in our model

46. Since the investor's risk aversion changes over time, expected returns also vary, and hence returns are predictable.

47. E. Sensitivity Analysis Raising k has a large effect on the equity premium since it raises average loss aversion. It also raises volatility somewhat because a higher k means more rapid changes in risk aversion.

50. Ⅵ.THE IMPORTANCE OF PRIOR OUTCOMES Benartzi and Thaler [1995] show that a loss-averse investor is very reluctant to allocate much of his portfolio to stocks even when faced with the large historical equity premium. The investor chooses consumption C t and an allocation to the risky asset S t to maximize where

51. PROPOSITION 3. the equations that govern equilibrium prices in an economy like Economy II where consumption and dividends are separated out. an equilibrium in which the risk-free rate and the stock's pricedividend ratio are both constant and stock returns are i.i.d. there exists an equilibrium in which the gross risk-free interest rate is constant at the stock's price-dividend ratio, ft, is constant at f and given by Where That returns are i.i.d. is a direct consequence of the fact that the price- dividend ratio is constant. ft == P t /D t,as follows:

53. A model which relies on loss aversion alone cannot provide a complete description of aggregate stock market behavior. The standard deviations of returns in Table XIII are much lower than both the empirical value and the values in Table IV. (46) The unrealistically low stock return volatility hampers its ability to explain the equity premium. loss aversion can help to understand the equity premium this mechanism is a changing degree of loss aversion, but it could also be based on changing perceptions of risk, or excessive extrapolation of cash flows into the future.

54. Ⅶ. CONCLUSION 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 how loss averse they are, depends on their prior investment performance. Stock returns have a high mean, are excessively volatile, and are significantly predictable in the time series. They are also only weakly correlated with consumption growth. Questions for further investigation (1) it is not immediately clear what investors are loss averse about. Eg. mental accounting (2) what extent our preferences can explain not only financial data but also experimental evidence on attitudes to risky gambles. small-scale gambles large-scale gambles