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Myopic Loss Aversion, Asymmetric Correlations, and the Home Bias

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  • Carlos Viana de Carvalho
  • Kevin Amonlirdviman

Abstract

Myopic loss aversion has been used to explain why a high equity premium might be consistent with plausible levels of risk aversion. The intuition is that it plays the role of high risk aversion in portfolio choice. But if so, should these agents not perceive larger gains from international diversification than standard preference agents with realistic levels of risk aversion? They might not because stock market returns are asymmetrically correlated. We analyze the portfolio problem of a myopic loss averse investor who has to choose between home and foreign equities in the presence of asymmetrically correlated returns. Perhaps surprisingly, depending on the horizon, this investor behaves similarly to one with standard preferences in the context of the home bias puzzle

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File URL: http://repec.org/esLATM04/up.3399.1080794900.pdf
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Paper provided by Econometric Society in its series Econometric Society 2004 Latin American Meetings with number 61.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:latm04:61

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Keywords: myopic loss aversion; home bias; asymmetric correlations; equity premium puzzle;

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  1. King, Mervyn & Sentana, Enrique & Wadhwani, Sushil, 1994. "Volatility and Links between National Stock Markets," Econometrica, Econometric Society, vol. 62(4), pages 901-33, July.
  2. Samuelson, Paul A, 1969. "Lifetime Portfolio Selection by Dynamic Stochastic Programming," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 239-46, August.
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  7. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
  8. Tesar, Linda L. & Werner, Ingrid M., 1995. "Home bias and high turnover," Journal of International Money and Finance, Elsevier, vol. 14(4), pages 467-492, August.
  9. French, Kenneth R & Poterba, James M, 1991. "Investor Diversification and International Equity Markets," American Economic Review, American Economic Association, vol. 81(2), pages 222-26, May.
  10. Andrew Ang & Geert Bekaert, 2002. "International Asset Allocation With Regime Shifts," Review of Financial Studies, Society for Financial Studies, vol. 15(4), pages 1137-1187.
  11. Huberman, Gur, 2001. "Familiarity Breeds Investment," Review of Financial Studies, Society for Financial Studies, vol. 14(3), pages 659-80.
  12. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  13. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
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