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The neo-classical economic theory has developed a very elegant theory of asset pricing. According to this theory, rational investors contemplate the potential valuations of assets under different possible economic scenarios, called states of the world. For an economist, the first intuition or rational approach is to suggest that the value of the asset can and should be evaluated by considering the probabilities of the respective states and the impacts on the average investors perceived satisfactions. The satisfaction perceived by an investor is supposedly measured with a mathematical function called utility function. Still, this approach is not as rational as it seems.
First, the states of the world might be difficult to determine and the...
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