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How Investors Face Financial Risk: Loss Aversion and Wealth AllocationErick Williams RengifoFordham University Emanuela TrifanCatholic 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 Abstract: 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 Allocation Accepted Paper SeriesDate posted: April 13, 2010 ; Last revised: March 12, 2012Suggested CitationContact Information
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