Beta and Coskewness Pricing: Perspective from Probability Weighting

Does Subjective Evaluation of Probability Impact Asset Prices? The Nobel Prize–winning capital asset pricing model (CAPM) predicts that expected excess return any is positively proportional to its exposure the overall market: beta, leading an upward-sloping security market line. However, this prediction contradicted by empirical studies return–beta slope often flat or even downward-sloping, a puzzle called “beta anomaly.” CAPM premised upon notion participants are all rational, including they able objectively evaluate probabilities. evidence abounds individuals unable do so, examples being purchase lottery tickets and insurance products, in which extremely small probabilities winning losing big exaggerated. This phenomenon distorting at both tails “probability weighting” (PW), key component modern behavioral finance. paper “Beta Coskewness Pricing: Perspective from Weighting” approaches beta anomaly through PW. It offers explanation via new theoretical involving PW extensive study.