The equity premium puzzle, first documented by Mehra and Prescott, refers to the empirical fact that stocks have greatly outperformed bonds over the last century. As Mehra and Prescott point out, it appears difficult to explain the magnitude of the equity premium within the usual economics...

We study equilibrium firm-level stock returns in two economies: one in which investors are loss averse over the fluctuations of their stock portfolio and another in which they are loss averse over the fluctuations of individual stocks that they own. Both approaches can shed light on empirical...

We present a new model of asset prices in which investors evaluate risk according to prospect theory and examine its ability to explain 23 prominent stock market anomalies. The model incorporates all the elements of prospect theory, takes account of investors’ prior gains and losses, and makes...

Behavioral finance tries to make sense of financial data using models that are based on psychologically accurate assumptions about people's beliefs, preferences, and cognitive limits. I review behavioral finance approaches to understanding asset prices and trading volume, with particular...

We examine the causal effect of limits to arbitrage on 11 well-known asset pricing anomalies using the pilot program of Regulation SHO, which relaxed short-sale constraints for a quasi-random set of pilot stocks, as a natural experiment. We find that the anomalies became weaker on portfolios...

We propose a new model of exchange rates, which yields a theory of the forward premium puzzle. Our explanation combines two ingredients: the possibility of rare economic disasters, and an asset view of the exchange rate. Our model is frictionless, has complete markets, and works for an arbitrary...

Why do value stocks have higher average returns than growth stocks, despite having lower risk? Why do these stocks exhibit positive abnormal performance while growth stocks exhibit negative abnormal performance? This paper offers a rare-events based explanation that can also account for the high...