Why Stocks May Disappoint

55 Pages Posted: 30 Mar 2000  

Andrew Ang

BlackRock, Inc

Geert Bekaert

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Jun Liu

University of California, San Diego (UCSD) - Rady School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: March 2000

Abstract

Recently much progress has been made in developing optimal portfolio choice models accomodating time-varying opportunity sets, but unless investors are unreasonably risk averse, optimal holdings include unreasonably large equity positions. One reason is that most studies assume investors behave as expected utility maximizers with power utility. In this article, we provide a formal treatment of both static and dynamic portfolio choice using the Disappointment Aversion preferences of Gul (1991). While different from the Kahneman-Tversky (1979) loss aversion utility, these preferences imply asymmetric aversion to gains versus losses and are consistent with the tendency of some people to like lottery-type gambles but dislike stock investments. By calibrating a number of data generating processes to actual US data on stock and bond returns, we find very reasonable portfolios for moderately disappointment averse investors with utility functions exhibiting low curvature. Disappointment aversion preferences affect intertemporal hedging demands and the state dependence of asset allocation in such a way as to not be replicable by standard expected utility functions with higher curvature. Furthermore, it is easy to reconcile the large equity premium observed in the data with disappointment aversion utility of low curvature and reasonable disappointment.

JEL Classification: G11, G12, C32

Suggested Citation

Ang, Andrew and Bekaert, Geert and Liu, Jun, Why Stocks May Disappoint (March 2000). EFA 0669. Available at SSRN: https://ssrn.com/abstract=216850 or http://dx.doi.org/10.2139/ssrn.216850

Andrew Ang (Contact Author)

BlackRock, Inc ( email )

55 East 52nd Street
New York City, NY 10055
United States

Geert Bekaert

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jun Liu

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States
858.534.2022 (Phone)
5858.534.0745 (Fax)

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