Journal
MATHEMATICAL FINANCE
Volume 26, Issue 3, Pages 558-588Publisher
WILEY-BLACKWELL
DOI: 10.1111/mafi.12070
Keywords
rank-dependent utility; probability weighting; Arrow-Debreu equilibrium; state-price density
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Funding
- NSFC (National Natural Science Foundation of China) [11231005]
- NCMIS (National Center for Mathematics and Interdisciplinary Sciences), Chinese Academy of Sciences
- GRF grant [CUHK419511]
- University of Oxford
- Oxford-Man Institute of Quantitative Finance
- East China Normal University
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We provide conditions on a one-period-two-date pure exchange economy with rank-dependent utility agents under which Arrow-Debreu equilibria exist. When such an equilibrium exists, we show that the state-price density is a weighted marginal rate of intertemporal substitution of a representative agent, where the weight depends on the differential of the probability weighting function. Based on the result, we find that asset prices depend upon agents' subjective beliefs regarding overall consumption growth, and we offer a direction for possible resolution of the equity premium puzzle.
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