Value Averaging and How Dynamic Strategies Bias the IRR and Modified IRR

41 Pages Posted: 15 May 2010 Last revised: 3 Sep 2013

See all articles by Simon Hayley

Simon Hayley

City University London - Sir John Cass Business School

Date Written: August 30, 2013

Abstract

This paper demonstrates that the IRR is a biased indicator of expected profits for Value Averaging (VA) and for any other dynamic strategy which is based on a target return or profit level, or which takes profits or “doubles down” following losses. The modified IRR is similarly biased. VA is popular, but this paper demonstrates that it is an inefficient investment strategy (for any plausible investor risk preferences) and quantifies the resulting welfare losses. VA’s popularity appears to be due to investors making a cognitive error in assuming that the strategy’s attractive IRR implies greater expected terminal wealth.

Keywords: value averaging, dollar cost, formula strategy

JEL Classification: G10, G11

Suggested Citation

Hayley, Simon, Value Averaging and How Dynamic Strategies Bias the IRR and Modified IRR (August 30, 2013). Available at SSRN: https://ssrn.com/abstract=1606347 or http://dx.doi.org/10.2139/ssrn.1606347

Simon Hayley (Contact Author)

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

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