Portfolio choice when stock returns may disappoint: An empirical analysis based on L-moments

Abstract

We empirically examine the equity portfolio choice of investors with generalized disappointment aversion (GDA) preferences. Opposite to expected utility investors, GDA investors suffer large utility losses from suboptimal trading strategies such as equally weighted portfolios. These losses arise from the sensitivity to disappointing returns rather than from the threshold below which returns are perceived to be disappointing. Using a newly developed estimation method based on L-moments, we find that high order L-moments up to order ten, unlike conventional moments, have a substantial and economically sensible impact on portfolio choice.

Keywords: choice under uncertainty, optimal portfolios, generalized disappointment aversion, higher-order moments

JEL Classification: C5, G12