Shortfall Aversion

43 Pages Posted: 20 Jun 2014 Last revised: 28 Sep 2017

See all articles by Paolo Guasoni

Paolo Guasoni

Boston University - Department of Mathematics and Statistics; Dublin City University - School of Mathematical Sciences; University of Bologna - Department of Statistics

Gur Huberman

Columbia University - Columbia Business School, Finance

Dan Ren

University of Dayton

Multiple version iconThere are 3 versions of this paper

Date Written: March 9, 2017

Abstract

Shortfall aversion reflects the higher utility loss of spending cuts from a reference than the utility gain from similar spending increases. Inspired by Prospect Theory's loss aversion and the peak-end rule, this paper posits a model of utility from spending scaled by past peak-spending. In contrast to traditional models, which call for spending rates proportional to wealth, the optimal policy in this model implies a constant spending rate equal to the historical peak when wealth is relatively large. The spending rate increases when wealth reaches a model-determined multiple of peak spending. In 1926-2015, shortfall-averse spending is smooth and typically increasing.

Keywords: loss aversion, portfolio choice, consumption, endowments

JEL Classification: G11, G12

Suggested Citation

Guasoni, Paolo and Guasoni, Paolo and Huberman, Gur and Ren, Dan, Shortfall Aversion (March 9, 2017). Columbia Law and Economics Working Paper No. 483, Available at SSRN: https://ssrn.com/abstract=2456651 or http://dx.doi.org/10.2139/ssrn.2456651

Paolo Guasoni (Contact Author)

Boston University - Department of Mathematics and Statistics ( email )

Boston, MA 02215
United States

Dublin City University - School of Mathematical Sciences ( email )

Dublin
Ireland

HOME PAGE: http://www.guasoni.com

University of Bologna - Department of Statistics ( email )

Bologna, 40126
Italy

Gur Huberman

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
New York, NY 10027
United States
(212) 854-5553 (Phone)

Dan Ren

University of Dayton ( email )

300 College Park
Dayton, OH 45469
United States

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