Explaining Returns with Loss Aversion

33 Pages Posted: 10 Feb 1998

See all articles by Tyler Shumway

Tyler Shumway

University of Michigan at Ann Arbor, The Stephen M. Ross School of Business

Date Written: November 20, 1997

Abstract

I develop and test an equilibrium asset pricing model based on loss averse investors. The model specifies a pricing kernel that is a nonmonotonic function of the market return. It also implies that investors demand a higher risk premium for risk associated with negative market returns than for positive market returns. The model assumes rational expectations and is consistent with no-arbitrage pricing. Estimates of the model's parameters are similar to values reported elsewhere. As the loss aversion literature predicts, the accuracy of the model depends on the frequency with which data is observed. Consistent with Benartzi and Thaler (1995), the model explains annual returns better than competing models, but it does not explain monthly, quarterly, or half-year returns. The model fits both returns that reflect the equity premium and stock returns alone.

JEL Classification: G12

Suggested Citation

Shumway, Tyler, Explaining Returns with Loss Aversion (November 20, 1997). Available at SSRN: https://ssrn.com/abstract=58442 or http://dx.doi.org/10.2139/ssrn.58442

Tyler Shumway (Contact Author)

University of Michigan at Ann Arbor, The Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
734-763-4129 (Phone)
734-936-0274 (Fax)

HOME PAGE: http://www.umich.edu/~shumway

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