Financial Loss Aversion Illusion
Review of Finance, forthcoming. This is the submitted version of doi: 10.1093/rof/rfz002
52 Pages Posted: 5 Jun 2014 Last revised: 3 Feb 2019
Date Written: July 27, 2017
We test the proposition that investors' ability to cope with financial losses is much better than they expect. In a panel survey with real investors from a large UK bank, we ask for subjective ratings of anticipated returns and experienced returns. The time period covered by the panel (2008-2010), with frequent losses and gains in the portfolios of investors, provides the required background to analyze the involved hedonic experiences. We examine how the subjective ratings behave relative to expected portfolio returns and experienced portfolio returns. Loss aversion is strong for anticipated outcomes with investors reacting over twice as sensitive to negative expected returns as to positive expected returns. However, when evaluating experienced returns, the effect diminishes by more than half and is well below commonly found loss aversion coefficients. It seems that a large part of investors' financial loss aversion results from a projection bias.
Keywords: Loss Aversion, Individual Investors, Expectations, Affective Forecasting, Projection Bias
JEL Classification: D03, D14, D81, G02, G11
Suggested Citation: Suggested Citation