Gain-Loss Portfolio Theory

50 Pages Posted: 16 Oct 2000

See all articles by Michael S. Rozeff

Michael S. Rozeff

SUNY at Buffalo - Department of Financial & Managerial Economics

Philip F. O'Connor

University of Auckland - Department of Accounting and Finance; University of Waikato - Management School

Date Written: September 2000

Abstract

We show the existence of a viable gain-loss portfolio theory, relevant for investors seeking high expected gain compared to expected loss. Diversification, in gain-loss theory, raises a portfolio's gain-loss ratio even when all component assets have identical gain-loss ratios, as long as some of the assets' gains occur when other assets lose, i.e., as long as there are unmatched gains and losses. We derive a gain-loss asset pricing model which implies that the market portfolio possesses the highest gain-loss ratio of all assets and which yields each asset's reward measure (co-gain) as proportional to its risk measure (co-loss). We show that the market equilibrium and/or the absence of arbitrage profits imply equality of prices of gain and loss of individual assets, portfolios, and assets in portfolios. Further analysis of gain and loss includes applications to leverage, net present value, and the decomposition of variance.

JEL Classification: G12

Suggested Citation

Rozeff, Michael S. and O'Connor, Philip F., Gain-Loss Portfolio Theory (September 2000). Available at SSRN: https://ssrn.com/abstract=241780 or http://dx.doi.org/10.2139/ssrn.241780

Michael S. Rozeff (Contact Author)

SUNY at Buffalo - Department of Financial & Managerial Economics ( email )

Buffalo, NY 14260
United States

Philip F. O'Connor

University of Auckland - Department of Accounting and Finance ( email )

Private Bag 92019
Auckland 1001
New Zealand
+649-923-9431 (Phone)

University of Waikato - Management School ( email )

Hamilton
New Zealand
+64 7 838 4466 (Phone)

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