The New CAPM Model Based On Prospect Theory

Different with international trade in narrow sense, multinational financial activities also have been an important part in international trade domain. As knowledge-intensive goods, financial merchandize have their own unique rules. That's why the international capital market chapter wins an important position in International Economics written by Paul R. Krugman. This paper is mainly about the combination of Prospect Theory and CAPM. It is more than half a century since the VMUT was proposed, and it also has been the basic foundation of considerable economic models. Meanwhile, due to the rigid hypothesis, especially the rational hypothesis, VMUT was also broadly doubted. The Prospect Theory, as the substitute of VMUT, was proposed in 1978. After applying PT as the foundation of CAPM, we find that the new model makes more senses both in theory and reality.Chapter one, introduces us the main theories of uncertainty and irrational research, especially the PT. Chapter two, shows us the process of new model illation based on the generalized CAPM. Chapter three, we compare the validity of two CAPM models with 17 stocks' data in Shanghai Stock Market, and find that the new one's result is more sensible. Chapter four, according to model's deficiency, we give a hint of further research in this direction.The most valuable part of this paper can be the application of irrational hypothesis in traditional economic model. However, what should be point out is that the model isn't a general model, and it is based on certain hypothesis. Furthermore, the mathematics model of PT itself hasn't been perfect, so there should be lots of improvements for our model, also. Whereas, the new model's empirical result in Shanghai Stock Market is acceptable.