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A Loss Aversion Performance Measure

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  • Farah, N.
  • Satchell, S.E.
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    Abstract

    The purpose of this paper is to propose an innovative method of evaluating the performance of active fund managers, by introducing to the field of performance measurement the more appealing loss aversion utility theory. We combine the latter to an already established performance measure developed by Grinblatt and Titman (1989), to construct a new and improved method of performance evaluation and then apply it for two distinct risk preference scenarios. The new methodology is used to evaluate the performance of a sample of UK pension funds over a 10-year period using the Knight, Satchell and Tran (1995) family of distributions for the excess returns. The results vary depending on the assumption of risk preferences: the results obtained in the first scenario are controversial, whereas for the second scenario, the new measure does seem to pick up on the timing skills exhibited by active fund managers and then reward them accordingly.

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    File URL: http://www.econ.cam.ac.uk/research/repec/cam/pdf/cwpe0333.pdf
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    Bibliographic Info

    Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0333.

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    Length: 72
    Date of creation: Jul 2003
    Date of revision:
    Handle: RePEc:cam:camdae:0333

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    Web page: http://www.econ.cam.ac.uk/index.htm

    Related research

    Keywords: Performance measures; Loss Aversion; Pension funds; KST Family; Active management;

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    1. Thaler, Richard H, et al, 1997. "The Effect of Myopia and Loss Aversion on Risk Taking: An Experimental Test," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 647-61, May.
    2. Grinblatt, Mark & Titman, Sheridan, 1993. "Performance Measurement without Benchmarks: An Examination of Mutual Fund Returns," The Journal of Business, University of Chicago Press, vol. 66(1), pages 47-68, January.
    3. J. L. Knight & S. E. Satchell & K. C. Tran, 1995. "Statistical modelling of asymmetric risk in asset returns," Applied Mathematical Finance, Taylor & Francis Journals, vol. 2(3), pages 155-172.
    4. Gneezy, Uri & Potters, Jan, 1997. "An Experiment on Risk Taking and Evaluation Periods," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 631-45, May.
    5. John Y. Campbell & Luis M. Viceira, 1999. "Consumption And Portfolio Decisions When Expected Returns Are Time Varying," The Quarterly Journal of Economics, MIT Press, vol. 114(2), pages 433-495, May.
    6. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
    7. Blake, David & Lehmann, Bruce N & Timmermann, Allan, 1999. "Asset Allocation Dynamics and Pension Fund Performance," The Journal of Business, University of Chicago Press, vol. 72(4), pages 429-61, October.
    8. Blume, Marshall E, 1970. "Portfolio Theory: A Step Toward Its Practical Application," The Journal of Business, University of Chicago Press, vol. 43(2), pages 152-73, April.
    9. Mark Grinblatt & Sheridan Titman, . "Mutual Fund Performance: An Analysis of Quarterly Portfolio Holdings," Rodney L. White Center for Financial Research Working Papers 23-88, Wharton School Rodney L. White Center for Financial Research.
    10. Chen, Hsiu-Lang & Jegadeesh, Narasimhan & Wermers, Russ, 2000. "The Value of Active Mutual Fund Management: An Examination of the Stockholdings and Trades of Fund Managers," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(03), pages 343-368, September.
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    15. Daniel, Kent, et al, 1997. " Measuring Mutual Fund Performance with Characteristic-Based Benchmarks," Journal of Finance, American Finance Association, vol. 52(3), pages 1035-58, July.
    16. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
    17. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
    18. Grinblatt, Mark & Titman, Sheridan, 1994. "A Study of Monthly Mutual Fund Returns and Performance Evaluation Techniques," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 29(03), pages 419-444, September.
    19. Elton, Edwin J & Gruber, Martin J & Blake, Christopher R, 1996. "The Persistence of Risk-Adjusted Mutual Fund Performance," The Journal of Business, University of Chicago Press, vol. 69(2), pages 133-57, April.
    20. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
    21. Admati, Anat R, et al, 1986. " On Timing and Selectivity," Journal of Finance, American Finance Association, vol. 41(3), pages 715-30, July.
    22. Jensen, Michael C, 1969. "Risk, The Pricing of Capital Assets, and the Evaluation of Investment Portfolios," The Journal of Business, University of Chicago Press, vol. 42(2), pages 167-247, April.
    23. Mark Grinblatt & Sheridan Titman, . "Portfolio Performance Evaluation: Old Issues and New Insights," Rodney L. White Center for Financial Research Working Papers 22-88, Wharton School Rodney L. White Center for Financial Research.
    24. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-36, May-June.
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