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From boom 'til bust: How loss aversion affects asset prices

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  • Berkelaar, Arjan
  • Kouwenberg, Roy

Abstract

This article studies the impact of heterogeneous loss averse investors on asset prices. In very good states loss averse investors become gradually less risk averse as wealth rises above their reference point, pushing up equity prices. When wealth drops below the reference point the investors become risk seeking and demand for stocks increases drastically, eventually leading to a forced sell-off and stock market bust in bad states. Heterogeneity in reference points and initial wealth of the loss averse investors does not change the salient features of the equilibrium price process, such as a relatively high equity premium, high volatility and counter-cyclical changes in the equity premium.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 33 (2009)
Issue (Month): 6 (June)
Pages: 1005-1013

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Handle: RePEc:eee:jbfina:v:33:y:2009:i:6:p:1005-1013

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Web page: http://www.elsevier.com/locate/jbf

Related research

Keywords: Asset pricing Equilibrium Behavioral finance Loss aversion;

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References

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Citations

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Cited by:
  1. Rengifo, Erick W. & Trifan, Emanuela, 2007. "Investors Facing Risk: Loss Aversion and Wealth Allocation Between Risky and Risk-Free Assets," Darmstadt Discussion Papers in Economics 28063, Darmstadt Technical University, Department of Business Administration, Economics and Law, Institute of Economics (VWL).
  2. Liu, Shuangzhe & Ma, Tiefeng & Polasek, Wolfgang, 2012. "Spatial System Estimators for Panel Models: A Sensitivity and Simulation Study," Economics Series 294, Institute for Advanced Studies.
  3. Fortin, Ines & Hlouskova, Jaroslava, 2010. "Optimal Asset Allocation Under Linear Loss Aversion," Economics Series 257, Institute for Advanced Studies.
  4. Ulrich Schmidt & Horst Zank, 2005. "What is Loss Aversion?," Journal of Risk and Uncertainty, Springer, vol. 30(2), pages 157-167, January.
  5. Hwang, Soosung & Satchell, Steve E., 2010. "How loss averse are investors in financial markets?," Journal of Banking & Finance, Elsevier, vol. 34(10), pages 2425-2438, October.
  6. Erick Rengifo & Emanuela Trifan, 2008. "How Investors Face Financial Risk Loss Aversion and Wealth Allocation," Fordham Economics Discussion Paper Series dp2008-01, Fordham University, Department of Economics.
  7. Stephen Satchell & Wei Xia, 2005. "Estimation of the Risk Attitude of the Representative UK Pension Fund Investor," Birkbeck Working Papers in Economics and Finance 0509, Birkbeck, Department of Economics, Mathematics & Statistics.
  8. Yao, Jing & Li, Duan, 2013. "Prospect theory and trading patterns," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 2793-2805.
  9. Nieto, Belén & Rubio, Gonzalo, 2011. "The volatility of consumption-based stochastic discount factors and economic cycles," Journal of Banking & Finance, Elsevier, vol. 35(9), pages 2197-2216, September.
  10. Jonathan Zinman, 2008. "Restricting consumer credit access: household survey evidence on effects around the Oregon rate cap," Working Papers 08-32, Federal Reserve Bank of Philadelphia.
  11. Germán López-Espinosa & Antonio Rubia & Laura Valderrama & Antonio Moreno, 2012. "Systemic Risk and Asymmetric Responses in the Financial Industry," IMF Working Papers 12/152, International Monetary Fund.
  12. Dichtl, Hubert & Drobetz, Wolfgang, 2011. "Portfolio insurance and prospect theory investors: Popularity and optimal design of capital protected financial products," Journal of Banking & Finance, Elsevier, vol. 35(7), pages 1683-1697, July.
  13. Fortin, Ines & Hlouskova, Jaroslava, 2012. "Optimal Asset Allocation under Quadratic Loss Aversion," Economics Series 291, Institute for Advanced Studies.
  14. Arjen Siegmann & Andr� Lucas, 2002. "Explaining Hedge Fund Investment Styles by Loss Aversion," Tinbergen Institute Discussion Papers 02-046/2, Tinbergen Institute.
  15. Mattos, Fabio & Garcia, Philip & Pennings, Joost M.E., 2008. "Probability weighting and loss aversion in futures hedging," Journal of Financial Markets, Elsevier, vol. 11(4), pages 433-452, November.

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