Behavioral finance.

• Position: National Bureau of Economic Research meeting

The NBER's Group on Behavioral Finance held its spring meeting in Cambridge on April 10. Project directors Robert J. Shiller, NBER and Yale University, and Richard H. Thaler, NBER and University of Chicago, organized this program:

Nicholas Barberis, Harvard University, Ming Huang, Stanford University, and Tano Santos, University of Chicago, "Prospect Theory and Asset Prices"

Discussant: Sendhil Mullainathan, NBER and MIT

Robert J. Shiller, "Measuring Bubble Expectations and Investor Confidence" (NBER Working Paper No. 7008)

Discussant: Werner DeBondt, University of Wisconsin

Harrison Hong, Stanford University, and Jeremy c. Stein, NBER and MIT, "Differences of Opinion, Rational Arbitrage, and Market Crashes"

Discussant: Olivier J. Blanchard, NBER and MIT

William N. Goetzmann, NBER and Yale University, and Massimo Massa, INSEAD, "Index Funds and Stock Market Growth" (NBER Working Paper No. 7033)

Discussant: Andrew Metrick, NBER and Harvard University

Jeff Wurgler and Ekaterina Zhuravskaya, Harvard University, "Does Arbitrage Flatten Demand Curves for Stocks?"

Discussant: Randall Morck, University of Alberta

Allen Poteshman, University of Chicago, "Does Investor Misreaction to New Information Increase in the Quantity of Previous Similar Information? Evidence from the Options Market"

Discussant: Ming Huang, Stanford University

Barberis, Huang, and Santos propose a new framework for pricing assets, derived in part from the traditional consumption-based approach but also incorporating two longstanding ideas in psychology: Kahneman and Tversky's (1979) prospect theory and the evidence of Thaler and Johnson (1990) and others on the influence of prior outcomes on risky choice. Consistent with prospect theory, investors in the authors' model derive utility not only from consumption levels but also from changes in the value of their asset holdings. The investors are much more sensitive to reductions than to increases in wealth. Moreover, the investors' utility from gains and losses in wealth depends on prior investment outcomes: prior gains cushion subsequent losses, while prior losses intensify the pain of subsequent shortfalls. Studying asset prices in the presence of a representative agent with preferences of this type, the authors find that their model can explain the high mean, volatility, and predictability of stock returns. The agent's risk-aversion changes over time as a function of investment performance: this generates time-varying risk...