Optimal Portfolio Choice Under Loss Aversion

Posted: 21 Nov 2006

See all articles by Arjan B. Berkelaar

Arjan B. Berkelaar

World Bank - Quantitative Strategies, Risk & Analytics Department; BF-Joint Library

Roy Kouwenberg

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); Mahidol University - College of Management

Thierry Post

Graduate School of Business of Nazarbayev University

Multiple version iconThere are 2 versions of this paper

Abstract

This paper analyzes the optimal investment strategy for loss averse investors, assuming a complete market and general Ito processes for the asset prices. The loss-averse investor follows a partial portfolio insurance strategy. When the investor's planning horizon is short (less than 5 years), he or she considerably reduces the initial portfolio weight of stocks compared to an investor with smooth power utility. The empirical section of the paper estimates the level of loss aversion implied by historical U.S. stock market data, using a representative agent model. We find that loss aversion and risk aversion cannot be disentangled empirically.

Keywords: Optimal portfolio choice, Behavioral finance, Loss aversion

JEL Classification: G11, G12, G15

Suggested Citation

Berkelaar, Arjan B. and Kouwenberg, Roy R. P. and Post, Thierry, Optimal Portfolio Choice Under Loss Aversion. Review of Economics and Statistics, Vol. 86, No. 4, pp. 973-987, November 2004. Available at SSRN: https://ssrn.com/abstract=946121

Arjan B. Berkelaar

World Bank - Quantitative Strategies, Risk & Analytics Department ( email )

1818 H Street NW
Washington, DC 20433
United States

BF-Joint Library

Roy R. P. Kouwenberg (Contact Author)

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

HOME PAGE: http://people.few.eur.nl/kouwenberg

Mahidol University - College of Management ( email )

69 Vipawadee Rangsit Road
Bangkok, 10400
Thailand

HOME PAGE: http://www.cmmu.mahidol.ac.th/main/faculty/aroy.asp

Thierry Post

Graduate School of Business of Nazarbayev University ( email )

53 Kabanbay Batyra Avenue
Astana, 010000
Kazakhstan

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