Loss Aversion, Survival and Asset Prices

55 Pages Posted: 14 Mar 2011 Last revised: 26 Feb 2016

See all articles by David Easley

David Easley

Cornell University - Department of Economics; Cornell University - Department of Information Science

Liyan Yang

University of Toronto - Rotman School of Management

Date Written: June 1, 2015

Abstract

This paper studies the wealth and pricing implications of loss aversion in the presence of arbitrageurs with Epstein-Zin preferences. Loss aversion affects an investor's survival prospects mainly through its effect on the investor's portfolio holdings. Loss-averse investors will be driven out of the market and do not affect long-run prices if their portfolio positions are further away from those corresponding to the log investor than arbitrageurs. In terms of wealth shares, the market selection process can be slow, but the selection force is nonetheless effective in terms of price impact, which highlights the importance of introducing preference heterogeneity in understanding asset prices.

Keywords: loss aversion; narrow framing; Epstein-Zin preferences; market selection; asset prices

JEL Classification: G11, G12, D50

Suggested Citation

Easley, David and Yang, Liyan, Loss Aversion, Survival and Asset Prices (June 1, 2015). Journal of Economic Theory, 2015, 160(12): 494-516. Available at SSRN: https://ssrn.com/abstract=1784367 or http://dx.doi.org/10.2139/ssrn.1784367

David Easley

Cornell University - Department of Economics ( email )

414 Uris Hall
Ithaca, NY 14853-7601
United States
607-255-6283 (Phone)
607-255-2818 (Fax)

Cornell University - Department of Information Science ( email )

402 Bill & Melinda Gates Hall
Ithaca, NY 14853
United States

Liyan Yang (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

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