Asset pricing models use simple utility instead of expected utility to match empirical return anomalies.
the verdict
SUPPORTED
the evidence backs this
refutedsupported
the weight of evidence
1 source for · 0 against
A 2003 peer-reviewed study demonstrates that asset valuation decisions are based on simple utility to capture the risk-return relationship and match empirical returns.
Investors base asset valuation decisions on current day movements in asset and market returns. This is shown in the risk-return relationship of the simple asset pricing model using a four-way partition of daily returns. The partitioning is derived from current movements in individual asset and market returns. The underlying behavioral theory is a valuation framework that generalizes von Neumann-Morgenstern expected utility and allows for some commonly observed anomalies. We test key elements of Kahneman and Tversky's (1979) prospect theory and find reference dependence, asymmetric valuation of gains and losses, and nonproportional marginal sensitivity to large changes in expected returns in 1986-2000 data for 100 companies: the Dow-Jones 30 industrials and 30 and 40 companies selected at random from the S&P mid cap and small cap index lists respectively.