  We explain the main concepts of Prospect Theory and Cumulative Prospect
Theory within the framework of rational dynamic asset pricing theory. We derive
option pricing formulas when asset returns are altered with a generalized
Prospect Theory value function or a modified Prelec weighting probability
function and introduce new parametric classes for Prospect Theory value
functions and weighting probability functions consistent with rational dynamic
pricing Theory. We study the behavioral finance notion of greed and fear from
the point of view of rational dynamic asset pricing theory and derive the
corresponding option pricing formulas in the case of asset returns that follow
continuous diffusion or discrete binomial trees.
