How Investors Face Financial Risk: Loss Aversion and Wealth Allocation
Erick Williams Rengifo
Catholic University of Leuven, Center for Operation Research and Econometrics (CORE); Darmstadt University of Technology - Institute of Economics - Department of Applied Econometrics; Department of Economics, Chair of Econometrics
March 1, 2010
Journal of CENTRUM Cathedra, Vol. 3, Issue 1, pp. 41-59, 2010
We studied how the capital allocation decisions and the loss version of nonprofessional investors change subject to behavioral factors. The optimal wealth allocation between risky and risk-free assets results within a value-at-risk (VaR) portfolio model, which involves assessing risk individually according to an extended prospect-theory framework. We showed how the past performance and the portfolio evaluation frequency affect investor behavior and prove myopic loss aversion holds across different evaluation frequencies. We also illustrated that 1 year is the optimal evaluation horizon at which, under practical constraints, maximization of risky holdings occurs. Finally, we presented evidence that indicates that researchers using standard VaR significance levels may be underestimating the loss aversion of individual investors.
Number of Pages in PDF File: 19
Keywords: Prospect Theory, Myopic Loss Aversion, Value-at-Risk, Portfolio Evaluation, Capital AllocationAccepted Paper Series
Date posted: April 13, 2010 ; Last revised: March 12, 2012
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