The Individually Acceptable Loss (IAL)

22 Pages Posted: 19 Sep 2013

See all articles by Erick W. Rengifo

Erick W. Rengifo

Fordham University - Department of Economics - Center for International Policy Studies (CIPS)

Emanuela Trifan

Bayerngas Energy

Rossen Trendafilov

St. Thomas Aquinas College - Business School

Multiple version iconThere are 2 versions of this paper

Date Written: September 2013

Abstract

This paper proposes a new, individual measure of market risk, denoted as the individually acceptable loss (IAL). This measure can be used by portfolio managers in order to better meet the individual profiles of their non-professional clients, including psychological traits. It can be easily assessed from general subjective and objective parameters. We formally define the IAL of loss averse investors, who narrowly frame financial investments, and are sensitive to the past performance of their risky portfolio. This individual risk measure is applied to the classic portfolio optimization framework in order to derive the optimal wealth allocation among different financial assets. Our empirical results suggest that previous optimization relying on a portfolio-exogenous VaR-formulation, underestimates the aversion of individual investors towards financial losses.

Keywords: market risk, prospect theory, loss aversion, capital allocation, Value-at-Risk

JEL Classification: C32, C35, G10

Suggested Citation

Rengifo, Erick W. and Trifan, Emanuela and Trendafilov, Rossen, The Individually Acceptable Loss (IAL) (September 2013). Available at SSRN: https://ssrn.com/abstract=2328290 or http://dx.doi.org/10.2139/ssrn.2328290

Erick W. Rengifo

Fordham University - Department of Economics - Center for International Policy Studies (CIPS) ( email )

United States
0017188174061 (Phone)
0017188173518 (Fax)

Emanuela Trifan

Bayerngas Energy ( email )

Albert-Roshupter-Str. 52
Munich, D-81369
Germany

Rossen Trendafilov (Contact Author)

St. Thomas Aquinas College - Business School ( email )

125 NY-340
Sparkill, NY 10976
United States

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