TITLE:
A Note on a Framework to Assess the Required Equity Risk Premium Using Cumulative Prospect Theory
AUTHORS:
Chris Holdsworth, Eben Maré
KEYWORDS:
Cumulative Prospect Theory; Equity Risk Premium; Investment Time Horizon; Multi-Asset Allocation
JOURNAL NAME:
Theoretical Economics Letters,
Vol.4 No.1,
February
18,
2014
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.