Relation Between Total Risk and Return: Analysis Under a New Paradigm

Risk and return do not have the clear cut negative relationship that we assume in our textbook treatment. Industry level studies in different countries have shown that risk and return are positively related above industry median (rate of return) but negatively related below industry median (rate of return). These findings contradict any model along the line of capital asset pricing model. It also is inconsistent with arbitrage pricing model. However, these observations are consistent with the Prospect Theory. The author views this phenomenon in the context of anomalies in finance; the author explores practical implications in terms of investment strategies.