Explaining Stocks’ Return Based on Prospect Theory

The way of allocating money to stock is the one of investors’ concerns. Investors mentally represent the stock by the distribution of its past returns and then evaluate this distribution in the way described by prospect theory. Therefore, prospect theory value as an influential factor in explaining stock returns has attracted many researchers. The purpose of this study was to investigate the effect of the prospect theory on future stock returns in listed companies in Tehran Stock Exchange. The statistical sample of the research, which has been selected by systematic elimination method, includes 104 companies from the companies listed in the Tehran Stock Exchange during the years 2012 to 2016. In this research, Fama and Franch model (1992) have been used to test the research hypotheses. The research model is fitted twice separately, once using panel data and again by the time series method, by the formulation of the portfolios. The results of the research show that the prospect theory value has a negative effect on stock returns.