Optimal portfolio choice under loss aversion
This paper analyses 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 planning horizon of the investor is short, i.e. less than 5 years, he or she considerably reduces the initial portfolio weight of stocks compared to an investor with smooth power utility. Consistent with popular investment advice, the initial portfolio weight of stocks of a loss averse investor typically increases with the investment horizon. The empirical section of the paper estimates the level of loss aversion implied by historical US stock market data, using a representative agent model. We find that loss aversion and risk aversion cannot be disentangled and provide a similar fit to the data.
|Keywords||behavioral finance, investment policy, loss aversion., optimal portfolio choice, stocks|
Berkelaar, A.B., Post, G.T., & Kouwenberg, R.R.P.. (2004). Optimal portfolio choice under loss aversion. The Review of Economics and Statistics, 973–987. Retrieved from http://hdl.handle.net/1765/6185