Author(s)

Zheng Qianyun

Corresponding Author

Zheng Qianyun

ABSTRACT

Conventional financial theories believe that risk and return are positively related due to individual ‘risk aversion’ psychology. However, after 1980 when the Bowman paradox appeared, investor risk aversion psychology and positive risk return correlation were questioned. Prospect theory is developed to support the risk return paradox. It believes that individuals or firm’s attitudes towards risk are a mixture of risk aversion and risk seeking. When a company’s performance or wealth is below the target, they will be risk seeking; in contrast, when their performance and wealth are above the reference point, they will be risk averse. Later on, many researchers started to estimate this relationships and the company’s risk attitude in different cases. Nevertheless, the results of these empirical studies are contradictory.This dissertation re-tests the risk return association using a cross-sectional research method, the results of which support the hypothesis of prospect theory.

KEYWORDS

Risk return relationship, risk return paradox, prospect theory,