Optimal Portfolio Choice Under Loss Aversion

31 Pages Posted: 29 Mar 2000 Last revised: 30 Jan 2012

Arjan B. Berkelaar

World Bank - Quantitative Strategies, Risk & Analytics Department; BF-Joint Library

Roy Kouwenberg

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); Mahidol University - College of Management

Thierry Post

Koc University - Graduate School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: February 1, 2000

Abstract

This paper analyses the optimal investment strategy for loss averse investors, assuming a complete market and general Ito processes for the asset prices. The loss averse investor follows a partial portfolio insurance strategy. When the planning horizon of the investor is short, i.e. less than 5 years, he or she considerably reduces the initial portfolio weight of stocks compared to an investor with smooth power utility. Consistent with popular investment advice, the initial portfolio weight of stocks of a loss averse investor typically increases with the investment horizon. The empirical section of the paper estimates the level of loss aversion implied by historical US stock market data, using a representative agent model. We find that loss aversion and risk aversion cannot be disentangled and provide a similar fit to the data.

JEL Classification: G11, G12

Suggested Citation

Berkelaar, Arjan B. and Kouwenberg, Roy and Post, Thierry, Optimal Portfolio Choice Under Loss Aversion (February 1, 2000). Review of Economics and Statistics, Vol. 86, No. 4, 2004. Available at SSRN: https://ssrn.com/abstract=214569 or http://dx.doi.org/10.2139/ssrn.214569

Arjan B. Berkelaar (Contact Author)

World Bank - Quantitative Strategies, Risk & Analytics Department ( email )

1818 H Street NW
Washington, DC 20433
United States

BF-Joint Library

Roy R. P. Kouwenberg

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

HOME PAGE: http://people.few.eur.nl/kouwenberg

Mahidol University - College of Management ( email )

69 Vipawadee Rangsit Road
Bangkok, 10400
Thailand

HOME PAGE: http://www.cmmu.mahidol.ac.th/main/faculty/aroy.asp

Thierry Post

Koc University - Graduate School of Business ( email )

Rumelifeneri Yolu
34450 Sariyer
Istanbul
Turkey

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