Loss Aversion with a State-Dependent Reference Point
AbstractThis study investigates reference-dependent choice with a stochastic, state-dependent reference point. The optimal reference-dependent solution equals the optimal consumption solution (no loss aversion) if the reference point is selected fully endogenously. Given that loss aversion is widespread, we conclude that the reference point generally includes an important exogenously fixed component. We develop a choice model in which adjustment costs can cause stickiness relative to an initial, exogenous reference point. Using historical U.S. investment benchmark data, we show that this model is consistent with diversification across bonds and stocks for a wide range of evaluation horizons, despite the historically high-risk premium of stocks compared to bonds. This paper was accepted by Peter Wakker, decision analysis.
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Bibliographic InfoArticle provided by INFORMS in its journal Management Science.
Volume (Year): 57 (2011)
Issue (Month): 6 (June)
behavioral finance; asset pricing; equity premium puzzle; reference-dependent preferences; loss aversion; stochastic reference point;
Other versions of this item:
- Enrico G. De Giorgi & Thierry Post, 2010. "Loss aversion with a state-dependent reference point," University of St. Gallen Department of Economics working paper series 2010 2010-23, Department of Economics, University of St. Gallen.
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Longitudinal Data; Spatial Time Series
- C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
- C93 - Mathematical and Quantitative Methods - - Design of Experiments - - - Field Experiments
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- Graham Loomes & Shepley Orr & Robert Sugden, 2009. "Taste uncertainty and status quo effects in consumer choice," Journal of Risk and Uncertainty, Springer, vol. 39(2), pages 113-135, October.
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