Prospect theory and the risk-return paradox: Some recent evidence

Pin Huang Chou, Robin K. Chou, Kuan Cheng Ko

Research output: Contribution to journalArticlepeer-review

20 Scopus citations

Abstract

There is extensive evidence indicating a negative risk-return relation when a firm's performance is measured based on accounting measures such as return on asset (ROA) and return on equity (ROE). Previous studies show that the risk-return paradox can be explained by the prospect theory, which predicts that managers' risk attitudes are different for firms of different performances. However, those studies mostly use earlier data from the COMPUSTAT database, which suffers from a survivorship bias. Failure to account for delisting firms may understate the risk-return relation. We reexamine the mixture of risk-seeking and risk-averse behaviors based on an updated 20-year sample period that is free from the survivorship problem. Interestingly, our results show stronger and robust evidence supporting the prospect theory during the period from 1984 to 2003.

Original languageEnglish
Pages (from-to)193-208
Number of pages16
JournalReview of Quantitative Finance and Accounting
Volume33
Issue number3
DOIs
StatePublished - 2009

Keywords

  • Least trimmed squares (LTS)
  • Prospect theory
  • Risk-return paradox
  • Survivorship bias

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