Journal
JOURNAL OF FINANCIAL ECONOMICS
Volume 107, Issue 3, Pages 715-739Publisher
ELSEVIER SCIENCE SA
DOI: 10.1016/j.jfineco.2012.11.002
Keywords
Prospect theory; Disposition effect; Momentum; Reversal; Turnover
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We build a general equilibrium model to examine the implications of prospect theory for the disposition effect, asset prices, and trading volume. Diminishing sensitivity predicts a disposition effect, price momentum, a reduced return volatility, and a positive return-volume correlation. Loss aversion generally predicts the opposite. In calibrated economies, there is a nontrivial range of preference parameters for prospect theory to simultaneously explain the disposition effect, the momentum effect, and the equity premium puzzle. Our model is helpful for understanding a wide range of financial phenomena and it also suggests new testable predictions. (C) 2012 Elsevier B.V. All rights reserved.
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