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Experimental economics and the theory of finance

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Encyclopedia of Finance

Abstract

Experimental findings and in particular Prospect Theory and Cumulative Prospect Theory contradict Expected Utility Theory, which in turn may have a direct implication to theoretical models in finance and economics. We show growing evidence against Cumulative Prospect Theory. Moreover, even if one accepts the experimental results of Cumulative Prospect Theory, we show that most theoretical models in finance are robust. In particular, the CAPM is intact even if investors make decisions based on change of wealth, employ decision weights, and are risk-seeking in the negative domain.

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Acknowledgement

The author acknowledges the financial support of the Krueger Center of Finance.

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Authors and Affiliations

  1. Hebrew University, Jerusalem, Israel

    Haim Levy

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  1. Haim Levy
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Editors and Affiliations

  1. Rutgers University, New Brunswick/Piscataway, USA

    Cheng-Few Lee

  2. San Francisco State University, San Francisco, USA

    Alice C. Lee

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© 2006 Springer Science+Business Media, Inc.

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Levy, H. (2006). Experimental economics and the theory of finance. In: Lee, CF., Lee, A.C. (eds) Encyclopedia of Finance. Springer, Boston, MA. https://doi.org/10.1007/978-0-387-26336-6_52

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  • DOI: https://doi.org/10.1007/978-0-387-26336-6_52

  • Publisher Name: Springer, Boston, MA

  • Print ISBN: 978-0-387-26284-0

  • Online ISBN: 978-0-387-26336-6

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