How Investors Face Financial Risk: Loss Aversion and Wealth Allocation

19 Pages Posted: 13 Apr 2010 Last revised: 12 Mar 2012

See all articles by Erick W. Rengifo

Erick W. Rengifo

Fordham University - Department of Economics - Center for International Policy Studies (CIPS)

Emanuela Trifan

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

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Date Written: March 1, 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.

Keywords: Prospect Theory, Myopic Loss Aversion, Value-at-Risk, Portfolio Evaluation, Capital Allocation

Suggested Citation

Rengifo, Erick W. and Trifan, Emanuela, How Investors Face Financial Risk: Loss Aversion and Wealth Allocation (March 1, 2010). Journal of CENTRUM Cathedra, Vol. 3, Issue 1, pp. 41-59, 2010. Available at SSRN: https://ssrn.com/abstract=1588189

Erick W. Rengifo (Contact Author)

Fordham University - Department of Economics - Center for International Policy Studies (CIPS) ( email )

United States
0017188174061 (Phone)
0017188173518 (Fax)

Emanuela Trifan

Catholic University of Leuven, Center for Operation Research and Econometrics (CORE) ( email )

34, Voie du Roman Pays
Louvain-la-Neuve, 1348
Belgium

Darmstadt University of Technology - Institute of Economics - Department of Applied Econometrics ( email )

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Darmstadt, 64283
Germany
+49(0)6151 166506 (Phone)
+49(0)6151 165652 (Fax)

HOME PAGE: http://www.tu-darmstadt.de/fb/fb1/vwl2/

Department of Economics, Chair of Econometrics ( email )

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Frankfurt am Main, 60323
Germany

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