Two Paradigms and Nobel Prizes in Economics: A Contradiction or Coexistence?

Item Type Journal paper
Abstract 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.
Authors De Giorgi, Enrico; Hens, Thorsten & Levy, Haim
Projects De Giorgi, Enrico & Audrino, Francesco (2010) Applying Recent Developments in Computational Statistics to Behavioral Asset Pricing and Portfolio Selection [applied research project]
Journal or Publication Title European Financial Management
Language English
Keywords asset pricing;cumulative prospect theory;capital asset pricing model;equilibrium
Subjects economics
HSG Classification contribution to scientific community
HSG Profile Area SEPS - Quantitative Economic Methods
Refereed Yes
Date March 2012
Publisher Wiley-Blackwell
Place of Publication Oxford UK
Volume 18
Number 2
Page Range 163-182
Number of Pages 20
ISSN 1354-7798
ISSN-Digital 1468-036X
Publisher DOI https://doi.org/10.1111/j.1468-036X.2011.00617.x
Depositing User Prof. Ph.D Enrico Giovanni De Giorgi
Date Deposited 22 Jun 2011 22:11
Last Modified 23 Aug 2016 11:10
URI: https://www.alexandria.unisg.ch/publications/145953

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De Giorgi, Enrico; Hens, Thorsten & Levy, Haim (2012) Two Paradigms and Nobel Prizes in Economics: A Contradiction or Coexistence? European Financial Management, 18 (2). 163-182. ISSN 1354-7798

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https://www.alexandria.unisg.ch/id/eprint/145953
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