TY  - JOUR
AU  - Barberis,Nicholas
AU  - Huang,Ming
TI  - Stocks as Lotteries: The Implications of Probability Weighting for Security Prices
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 12936
PY  - 2007
Y2  - February 2007
UR  - http://www.nber.org/papers/w12936
L1  - http://www.nber.org/papers/w12936.pdf
N1  - Author contact info:
Nicholas C. Barberis
Yale School of Management
135 Prospect Street
P O Box 208200
New Haven, CT 06520-8200
Tel: 203/436-0777
Fax: 203/432-6970
E-Mail: nick.barberis@yale.edu

Ming Huang
Johnson Graduate School of Management
319 Sage Hall
Cornell University
Ithaca, NY 14853
Tel: 607/255-9594
E-Mail: mh375@cornell.edu
AB  - We study the asset pricing implications of Tversky and Kahneman's (1992) cumulative prospect theory, with particular focus on its probability weighting component. Our main result, derived from a novel equilibrium with non-unique global optima, is that, in contrast to the prediction of a standard expected utility model, a security's own skewness can be priced: a positively skewed security can be "overpriced," and can earn a negative average excess return. Our results offer a unifying way of thinking about a number of seemingly unrelated financial phenomena, such as the low average return on IPOs, private equity, and distressed stocks; the diversification discount; the low valuation of certain equity stubs; the pricing of out-of-the-money options; and the lack of diversification in many household portfolios.
ER  -