Value Averaging and How Dynamic Strategies Bias the IRR and Modified IRR
41 Pages Posted: 15 May 2010 Last revised: 3 Sep 2013
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: Suggested Citation
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