Myopic Loss Aversion Revisited: the Effect of Probability Distortions in Choice Under Risk
IEW Working Paper No. 249
21 Pages Posted: 19 Feb 2007
Date Written: December 2006
Abstract
When the performance of a risky asset is frequently assessed, the probability of detecting a loss is high, which averts the loss averse investors. This effect is known as myopic loss aversion (MLA). This paper reexamines several recent experimental studies documenting the existence of MLA. A closer look at the experimental data reveals that the effect of MLA is largely neutralized by the overweighting of small probabilities and the underweighting of moderate and high probabilities. Remarkably, the two effects exactly balance each other out for conventional parameterizations of cumulative prospect theory. MLA alone cannot explain the observed investment decisions.
Keywords: Myopic loss aversion, experiment, probability weight, prospect theory
JEL Classification: D81, C91, D14
Suggested Citation: Suggested Citation
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