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Reference Dependence and Market Participation

Author

Listed:
  • Paolo Guasoni

    (Department of Mathematics and Statistics, Boston University, Boston, Massachusetts 02215; School of Mathematical Sciences, Dublin City University, Glasnevin, Dublin 9 D09 W6Y4, Ireland;)

  • Andrea Meireles-Rodrigues

    (Department of Mathematics, University of York, Heslington, York YO10 5DD, United Kingdom)

Abstract

This paper finds optimal portfolios for the reference-dependent preferences by Kőszegi and Rabin with piecewise linear gain–loss utility in a one-period model with a safe and a risky asset. If the return of the risky asset is highly dispersed relative to its potential gains, two personal equilibria arise, one of them including risky investments and the other one only safe holdings. In the same circumstances, the risky personal equilibrium entails market participation that decreases with loss aversion and gain–loss sensitivity, whereas the preferred personal equilibrium is sensitive to market and preference parameters. Relevant market parameters are not the expected return and standard deviation, but rather the ratio of expected gains to losses and the Gini index of the return.

Suggested Citation

  • Paolo Guasoni & Andrea Meireles-Rodrigues, 2020. "Reference Dependence and Market Participation," Mathematics of Operations Research, INFORMS, vol. 45(1), pages 129-156, February.
    • Handle: RePEc:inm:ormoor:v:45:y:2020:i:1:p:129-156
    DOI: 10.1287/moor.2018.0985
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    References listed on IDEAS

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    Cited by:

    1. Michail Anthropelos & Paul Schneider, 2021. "Optimal Investment and Equilibrium Pricing under Ambiguity," Swiss Finance Institute Research Paper Series 21-78, Swiss Finance Institute.
    2. Luca De Gennaro Aquino & Xuedong He & Moris Simon Strub & Yuting Yang, 2024. "Reference-dependent asset pricing with a stochastic consumption-dividend ratio," Papers 2401.12856, arXiv.org.

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