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A Note on a Framework to Assess the Required Equity Risk Premium Using Cumulative Prospect Theory
Investec Securities, Investec, Cape Town, South Africa
Department of Mathematics and Applied Mathematics, University of Pretoria, Pretoria, South Africa
- 1 Investec Securities, Investec, Cape Town, South Africa
- 2 Department of Mathematics and Applied Mathematics, University of Pretoria, Pretoria, South Africa
Theoretical Economics Letters·Volume 04 (2014)·Pages 89–90·Published 12 February 2014·DOI10.4236/tel.2014.41014
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Abstract
We provide a framework to ascertain the required equity risk premium (ERP) within the setting of Cumulative Prospect Theory (CPT) over arbitrary investment time periods. Once accounting for behavioral biases in estimating distributions (generated by using a simulation of asset returns based on a sampling procedure) and using a CPT utility function, it becomes apparent that the key determinant of the required ERP is an investor’s time horizon.
KeywordsCumulative Prospect TheoryEquity Risk PremiumInvestment Time HorizonMulti-Asset Allocation
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