The Individually Acceptable Loss (IAL)

Posted: 5 Mar 2007

See all articles by Erick W. Rengifo

Erick W. Rengifo

Fordham University - Department of Economics - Center for International Policy Studies (CIPS)

Emanuela Trifan

Catholic University of Leuven, Center for Operation Research and Econometrics (CORE); Darmstadt University of Technology - Institute of Economics - Department of Applied Econometrics; Department of Economics, Chair of Econometrics

Multiple version iconThere are 2 versions of this paper

Date Written: February 2007

Abstract

This paper proposes a new, individual measure of market risk, denoted as the individually acceptable loss (IAL). This measure can be used by portfolio managers in order to better meet the individual profiles of their non-professional clients, including psychological traits. It can be easily assessed from general subjective and objective parameters. We formally define the IAL of loss averse investors, who narrowly frame financial investments, and are sensitive to the past performance of their risky portfolio. This individual risk measure is applied to the classic portfolio optimization framework in order to derive the optimal wealth allocation among different financial assets. Our empirical results suggest that previous optimization relying on a portfolio-exogenous VaR-formulation, underestimates the aversion of individual investors towards financial losses.

Keywords: market risk, prospect theory,loss aversion, capital allocation, Value-at-Risk

JEL Classification: C32, C35, G10

Suggested Citation

Rengifo, Erick W. and Trifan, Emanuela, The Individually Acceptable Loss (IAL) (February 2007). Available at SSRN: https://ssrn.com/abstract=965742 or http://dx.doi.org/10.2139/ssrn.965742

Erick W. Rengifo (Contact Author)

Fordham University - Department of Economics - Center for International Policy Studies (CIPS) ( email )

United States
0017188174061 (Phone)
0017188173518 (Fax)

Emanuela Trifan

Catholic University of Leuven, Center for Operation Research and Econometrics (CORE) ( email )

34, Voie du Roman Pays
Louvain-la-Neuve, 1348
Belgium

Darmstadt University of Technology - Institute of Economics - Department of Applied Econometrics ( email )

Residenzschloss, Marktplatz 15
Darmstadt, 64283
Germany
+49(0)6151 166506 (Phone)
+49(0)6151 165652 (Fax)

HOME PAGE: http://www.tu-darmstadt.de/fb/fb1/vwl2/

Department of Economics, Chair of Econometrics ( email )

Gr├╝neburgplatz 1
Frankfurt am Main, 60323
Germany

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