TY - JOUR
T1 - Two Paradigms and Nobel Prizes in Economics
T2 - A Contradiction or Coexistence?
AU - Levy, Haim
AU - de Giorgi, Enrico G.
AU - Hens, Thorsten
PY - 2012/3
Y1 - 2012/3
N2 - Markowitz and Sharpe won the Nobel Prize in Economics for the development of Mean-Variance (M-V) analysis and the Capital Asset Pricing Model (CAPM). Kahneman won the Nobel Prize in Economics for the development of Prospect Theory. In deriving the CAPM, Sharpe, Lintner and Mossin assume expected utility (EU) maximisation in the face of risk aversion. Kahneman and Tversky suggest Prospect Theory (PT) as an alternative paradigm to EU theory. They show that investors distort probabilities, make decisions based on change of wealth, exhibit loss aversion and maximise the expectation of an S-shaped value function, which contains a risk-seeking segment. Can these two apparently contradictory paradigms coexist? We show in this paper that although CPT (and PT) is in conflict to EUT, and violates some of the CAPM's underlying assumptions, the Security Market Line Theorem (SMLT) of the CAPM is intact in the CPT framework. Therefore, the CAPM is intact also in CPT framework.
AB - Markowitz and Sharpe won the Nobel Prize in Economics for the development of Mean-Variance (M-V) analysis and the Capital Asset Pricing Model (CAPM). Kahneman won the Nobel Prize in Economics for the development of Prospect Theory. In deriving the CAPM, Sharpe, Lintner and Mossin assume expected utility (EU) maximisation in the face of risk aversion. Kahneman and Tversky suggest Prospect Theory (PT) as an alternative paradigm to EU theory. They show that investors distort probabilities, make decisions based on change of wealth, exhibit loss aversion and maximise the expectation of an S-shaped value function, which contains a risk-seeking segment. Can these two apparently contradictory paradigms coexist? We show in this paper that although CPT (and PT) is in conflict to EUT, and violates some of the CAPM's underlying assumptions, the Security Market Line Theorem (SMLT) of the CAPM is intact in the CPT framework. Therefore, the CAPM is intact also in CPT framework.
KW - Asset pricing
KW - Capital asset pricing model
KW - Cumulative prospect theory
KW - Equilibrium
UR - http://www.scopus.com/inward/record.url?scp=84858447035&partnerID=8YFLogxK
U2 - 10.1111/j.1468-036X.2011.00617.x
DO - 10.1111/j.1468-036X.2011.00617.x
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AN - SCOPUS:84858447035
SN - 1354-7798
VL - 18
SP - 163
EP - 182
JO - European Financial Management
JF - European Financial Management
IS - 2
ER -