Performance Measurement with Loss Aversion
AbstractWe examine a simple measure of portfolio performance based on prospect theory, which captures not only risk and return but also reflects differential aversion to upside and downside risk. The measure we propose is a ratio of gains to losses, with the gains and losses weighted (if desired) to reflect risk-aversion for gains and risk-seeking for losses. It can also be interpreted as the weighted ratio of the value of a call option to a put option, with the benchmark as the exercise price. When applying the loss-aversion performance measure to closed-end funds, we find that it gives significantly different rankings from those of conventional measures (such as the Sharpe ratio, Jensen's alpha, the Sortino ratio, and the Higher Moment measure), and gives the expected signs for the odd and even moments of tracking errors. However, loss-aversion performance is not more closely related to discounts on funds than are the conventional performance measures, so we have not found evidence that loss-aversion attracts investors to particular funds in the short-term.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5173.
Date of creation: Aug 2005
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Other versions of this item:
- Soosung Hwang & Gordon Gemmill & Mark Salmon, 2005. "Performance Measurement with Loss Aversion," Working Papers wp05-16, Warwick Business School, Financial Econometrics Research Centre.
- Mark Salmon & Soosung Hwang & Gordon Gemmill, 2005. "Performance Measurement with Loss Aversion," Working Papers wp05-08, Warwick Business School, Financial Econometrics Research Centre.
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-09-29 (All new papers)
- NEP-FIN-2005-09-29 (Finance)
- NEP-FMK-2005-09-29 (Financial Markets)
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