Asset Pricing for the Lottery-Like Security Under Probability Weighting : Based on Generalized Wang Transform

We present a two-stage lottery model with generalized Wang transform as a probability weighting function to formally derive investors’ demand for the lottery-like security. Probability overweight on higher expected payoffs accounts for investors’ overvaluation of the security with moderately lottery-like feature, raising the demand and driving up the price. Investors’ aggressive demand is enhanced by optimistic attitude segmented from probability weighting function and weakened by probability distortion towards extreme events if considering fundamental risks. Our model predicts overpricing in small securities with optimistic investors, and implies skewness pricing and “realized kurtosis puzzle”