<scp>CAPM</scp> and Skewness Pricing Under Probability Weighting: Based on the Generalised Wang Transform

ABSTRACT In this paper, we examine the conditions under which the capital asset pricing model (CAPM) holds with heterogeneous probability weighting. Using the generalised Wang transform within rank‐dependent expected utility, we show that CAPM holds for heterogeneous risk‐averse investors, while the security market line theorem (SMLT) applies to heterogeneous loss‐averse investors. However, CAPM under loss aversion requires homogeneous investors. Revisiting skewness pricing, we find that probability weighting, rather than the S‐shaped value function, drives skewness overpricing. The preference for skewed assets stems from the high distorted mean under probability weighting.