Why Investors are Loss Averters During Bull Markets and Gain Seekers During Bear Markets?
13 Pages Posted: 15 Aug 2015
Date Written: August 13, 2015
How does market trend sentiment affect investors’ asymmetric loss-gain tradeoffs? Several empirical tests indicate that investors are far more loss adverse during bull markets than during bear markets (see Hwang and Satchell, 2010; Hofschire et al, 2013). In this paper we provide a sound theoretical foundation for this empirical evidence. First, we discuss how to identify the subjectively perceived market trend sentiment. Then, we propose a reference dependent definition of loss aversion and gain appetite, that generalizes the Kahneman and Tversky (1979, p. 279) and Kahneman and Tversky (1992, p. 303) loss aversion definitions. Under mild technical assumptions on utility functions, asymmetrical loss-gain evaluations are normatively influenced by the investor perceived market trend. Specifically, investors are normatively lead to loss aversion during perceived bullish markets and to risk appetite during perceived bearish markets. This market trend dependence holds for the most popular utility functions used in the expected utility and prospect theory.
Keywords: Market sentiment, Investor sentiment, Bull and bear markets, Loss-gain asymmetry, Disposition Effect, van Zwet asymmetry conditions, Pearson utility functions.
JEL Classification: G1, D81.
Suggested Citation: Suggested Citation