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.
References
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