Template-Type: ReDIF-Paper 1.0
Author-Name: Berkelaar, A.B.
Author-Name-Last: Berkelaar
Author-Name-First: Arjan
Author-Name: Kouwenberg, R.R.P.
Author-Name-Last: Kouwenberg
Author-Name-First: Roy
Author-Person: pko16
Title: Optimal portfolio choice under loss aversion
Abstract: Prospect theory and loss aversion play a dominant role in behavioral finance. In this paper we derive closed-form solutions for optimal portfolio choice under loss aversion. When confronted with gains a loss averse investor behaves similar to a portfolio insurer. When confronted with losses, the investor aims at maximizing the probability that terminal wealth exceeds his aspiration level. Our analysis indicates that a representative agent model with loss aversion cannot resolve the equity premium puzzle. We also extend the martingale methodology to allow for more general utility functions and provide a simple approach to incorporate skewed and fat-tailed return distributions.
Creation-Date: 2000-03-01
File-URL: https://repub.eur.nl/pub/1641/feweco20000301140536.pdf
File-Format: application/pdf
Series: RePEc:ems:eureir
Number: EI 2000-08/A
Keywords: behavioral finance, loss aversion, optimal asset allocation
Handle: RePEc:ems:eureir:1641