Optimal Portfolio Choice Under Loss Aversion
Arjan B. Berkelaar
World Bank - Quantitative Strategies, Risk & Analytics Department; BF-Joint Library
Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); Mahidol University - College of Management
Koc University - Graduate School of Business
February 1, 2000
Review of Economics and Statistics, Vol. 86, No. 4, 2004
This paper analyses the optimal investment strategy for loss averse investors, assuming a complete market and general Ito processes for the asset prices. The loss averse investor follows a partial portfolio insurance strategy. When the planning horizon of the investor is short, i.e. less than 5 years, he or she considerably reduces the initial portfolio weight of stocks compared to an investor with smooth power utility. Consistent with popular investment advice, the initial portfolio weight of stocks of a loss averse investor typically increases with the investment horizon. The empirical section of the paper estimates the level of loss aversion implied by historical US stock market data, using a representative agent model. We find that loss aversion and risk aversion cannot be disentangled and provide a similar fit to the data.
Number of Pages in PDF File: 31
JEL Classification: G11, G12working papers series
Date posted: March 29, 2000 ; Last revised: January 30, 2012
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo4 in 0.328 seconds