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Ex-ante Valuation based on Prospect Theory

Author

Listed:
  • Fang, Yi
  • Niu, Hui
  • Lin, Yuen

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.

Suggested Citation

  • Fang, Yi & Niu, Hui & Lin, Yuen, 2023. "Ex-ante Valuation based on Prospect Theory," MPRA Paper 116386, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:116386
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    References listed on IDEAS

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    More about this item

    Keywords

    ex-ante valuation; prospect theory; equilibrium; liquidity; crash; jackpot;
    All these keywords.

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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