One for the Gain, Three for the Loss
AbstractI derive indifference curves in mean-standard deviation space for investors with prospect theory preferences when returns are normally distributed. The normality assumption creates a mapping between model parameters and the investment opportunity set. The model is then calibrated to historical return data for various assumptions regarding the set of admissible risky assets. It is found that the parameter for loss aversion must be higher than three for investors to hold finitely leveraged portfolios. For lower rates of loss aversion, in particular those proposed in the earlier experimental literature, the allocation to risky assets is infinite. Numerical simulations produce similar results when the normality assumption is abandoned.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Institute for Financial Research in its series SIFR Research Report Series with number 20.
Length: 38 pages
Date of creation: 15 Apr 2004
Date of revision:
Contact details of provider:
Postal: Institute for Financial Research Drottninggatan 89, SE-113 60 Stockholm, Sweden
Web page: http://www.sifr.org/
More information through EDIRC
Investor behavior; Portfolio choice; Prospect theory;
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
This paper has been announced in the following NEP Reports:
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
- Berkelaar, A.B. & Kouwenberg, R.R.P., 2000.
"Optimal portfolio choice under loss aversion,"
Econometric Institute Research Papers
EI 2000-08/A, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
- Kahneman, Daniel & Tversky, Amos, 1979.
"Prospect Theory: An Analysis of Decision under Risk,"
Econometric Society, vol. 47(2), pages 263-91, March.
- Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
- Kroll, Yoram & Levy, Haim & Rapoport, Amnon, 1988. "Experimental Tests of the Separation Theorem and the Capital Asset Pricing Model," American Economic Review, American Economic Association, vol. 78(3), pages 500-519, June.
- R. Mehra & E. Prescott, 2010.
"The equity premium: a puzzle,"
Levine's Working Paper Archive
1401, David K. Levine.
- Canner, Niko & Mankiw, N Gregory & Weil, David N, 1997.
"An Asset Allocation Puzzle,"
American Economic Review,
American Economic Association, vol. 87(1), pages 181-91, March.
- Andrew Ang & Geert Bekaert & Jun Liu, 2000.
"Why Stocks May Disappoint,"
NBER Working Papers
7783, National Bureau of Economic Research, Inc.
- Nicholas Barberis & Ming Huang & Richard Thaler, 2003. "Individual Preferences, Monetary Gambles and the Equity Premium," NBER Working Papers 9997, National Bureau of Economic Research, Inc.
- Yacine AÏT-SAHALIA, & Michael W. BRANDT, 2001.
"Variable Selection for Portfolio Choice,"
FAME Research Paper Series
rp34, International Center for Financial Asset Management and Engineering.
- Shlomo Benartzi & Richard H. Thaler, 1993.
"Myopic Loss Aversion and the Equity Premium Puzzle,"
NBER Working Papers
4369, National Bureau of Economic Research, Inc.
- Benartzi, Shlomo & Thaler, Richard H, 1995. "Myopic Loss Aversion and the Equity Premium Puzzle," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 73-92, February.
- Campbell, John Y. & Viceira, Luis M., 2002. "Strategic Asset Allocation: Portfolio Choice for Long-Term Investors," OUP Catalogue, Oxford University Press, number 9780198296942.
- Moshe Levy & Haim Levy, 2002. "Prospect Theory: Much Ado About Nothing?," Management Science, INFORMS, vol. 48(10), pages 1334-1349, October.
- 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.
- Gneezy, U. & Potters, J.J.M., 1997. "An experiment on risk taking and evaluation periods," Open Access publications from Tilburg University urn:nbn:nl:ui:12-73908, Tilburg University.
- Gneezy, U. & Potters, J.J.M., 1996. "An experiment on risk taking and evaluation periods," Discussion Paper 1996-61, Tilburg University, Center for Economic Research.
- Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Econometric Society, vol. 59(3), pages 667-86, May.
- Haim Levy & Enrico De Giorgi & Thorsten Hens, . "Prospect Theory and the CAPM: A contradiction or coexistence?," IEW - Working Papers 157, Institute for Empirical Research in Economics - University of Zurich.
- 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.
- Campbell R. Harvey & Akhtar Siddique, 2000. "Conditional Skewness in Asset Pricing Tests," Journal of Finance, American Finance Association, vol. 55(3), pages 1263-1295, 06.
- Eugene F. Fama & Kenneth R. French, 2002.
"The Equity Premium,"
Journal of Finance,
American Finance Association, vol. 57(2), pages 637-659, 04.
- Nicholas Barberis, 2000. "Investing for the Long Run when Returns Are Predictable," Journal of Finance, American Finance Association, vol. 55(1), pages 225-264, 02.
- 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.
- Fishburn, Peter C, 1977. "Mean-Risk Analysis with Risk Associated with Below-Target Returns," American Economic Review, American Economic Association, vol. 67(2), pages 116-26, March.
- Levy, Haim & Wiener, Zvi, 1998. "Stochastic Dominance and Prospect Dominance with Subjective Weighting Functions," Journal of Risk and Uncertainty, Springer, vol. 16(2), pages 147-63, May-June.
- Richard H. Thaler & Eric J. Johnson, 1990. "Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice," Management Science, INFORMS, vol. 36(6), pages 643-660, June.
- Porter, R Burr, 1974. "Semivariance and Stochastic Dominance: A Comparison," American Economic Review, American Economic Association, vol. 64(1), pages 200-04, March.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Anki Helmer).
If references are entirely missing, you can add them using this form.