Advanced Search
MyIDEAS: Login to save this paper or follow this series

Optimal Asset Allocation under Quadratic Loss Aversion

Contents:

Author Info

  • Fortin, Ines

    (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria)

  • Hlouskova, Jaroslava

    (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria, and School of Business and Economics, Thompson Rivers University, Kamloops, British Columbia, Canada)

Abstract

We study the asset allocation of a quadratic loss-averse (QLA) investor and derive conditions under which the QLA problem is equivalent to the mean-variance (MV) and conditional value-at-risk (CVaR) problems. Then we solve analytically the two-asset problem of the QLA investor for a risk-free and a risky asset. We find that the optimal QLA investment in the risky asset is finite, strictly positive and is minimal with respect to the reference point for a value strictly larger than the risk-free rate. Finally, we implement the trading strategy of a QLA investor who reallocates her portfolio on a monthly basis using 13 EU and US assets. We find that QLA portfolios (mostly) outperform MV and CVaR portfolios and that incorporating a conservative dynamic update of the QLA parameters improves the performance of QLA portfolios. Compared with linear loss-averse portfolios, QLA portfolios display significantly less risk but they also yield lower returns.

Download Info

If 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.
File URL: http://www.ihs.ac.at/publications/eco/es-291.pdf
File Function: First version, 2012
Download Restriction: no

Bibliographic Info

Paper provided by Institute for Advanced Studies in its series Economics Series with number 291.

as in new window
Length: 44 pages
Date of creation: Sep 2012
Date of revision:
Handle: RePEc:ihs:ihsesp:291

Contact details of provider:
Postal: Stumpergasse 56, A-1060 Vienna, Austria
Phone: ++43 - (0)1 - 599 91 - 0
Fax: ++43 - (0)1 - 599 91 - 555
Web page: http://www.ihs.ac.at
More information through EDIRC

Order Information:
Postal: Institute for Advanced Studies - Library, Stumpergasse 56, A-1060 Vienna, Austria

Related research

Keywords: Quadratic loss aversion; prospect theory; portfolio optimization; MV and CVaR portfolios; investment strategy;

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
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.:
as in new window
  1. Fortin, Ines & Hlouskova, Jaroslava, 2010. "Optimal Asset Allocation Under Linear Loss Aversion," Economics Series 257, Institute for Advanced Studies.
  2. 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.
  3. André Lucas & Arjen Siegmann, 2008. "The Effect of Shortfall as a Risk Measure for Portfolios with Hedge Funds," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 35(1-2), pages 200-226.
  4. Siegmann, Arjen, 2007. "Optimal investment policies for defined benefit pension funds," Journal of Pension Economics and Finance, Cambridge University Press, vol. 6(01), pages 1-20, March.
  5. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  6. Epstein, Larry G. & Zin, Stanley E., 1990. "'First-order' risk aversion and the equity premium puzzle," Journal of Monetary Economics, Elsevier, vol. 26(3), pages 387-407, December.
  7. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  8. Nicholas Barberis & Ming Huang, 2001. "Mental Accounting, Loss Aversion, and Individual Stock Returns," NBER Working Papers 8190, National Bureau of Economic Research, Inc.
  9. Berkelaar, Arjan & Kouwenberg, Roy, 2009. "From boom 'til bust: How loss aversion affects asset prices," Journal of Banking & Finance, Elsevier, vol. 33(6), pages 1005-1013, June.
  10. Ulrich Schmidt & Chris Starmer & Robert Sugden, 2008. "Third-generation prospect theory," Journal of Risk and Uncertainty, Springer, vol. 36(3), pages 203-223, June.
  11. Nicholas Barberis, 2001. "Mental Accounting, Loss Aversion, and Individual Stock Returns," Journal of Finance, American Finance Association, vol. 56(4), pages 1247-1292, 08.
  12. Enrico Giorgi & Thorsten Hens, 2006. "Making prospect theory fit for finance," Financial Markets and Portfolio Management, Springer, vol. 20(3), pages 339-360, September.
  13. Xue Dong He & Xun Yu Zhou, 2011. "Portfolio Choice Under Cumulative Prospect Theory: An Analytical Treatment," Management Science, INFORMS, vol. 57(2), pages 315-331, February.
  14. Francisco J. Gomes, 2005. "Portfolio Choice and Trading Volume with Loss-Averse Investors," The Journal of Business, University of Chicago Press, vol. 78(2), pages 675-706, March.
  15. Jaroslava Hlouskova & Panagiotis Tsigaris, 2012. "Capital income taxation and risk taking under prospect theory," International Tax and Public Finance, Springer, vol. 19(4), pages 554-573, August.
  16. Hwang, Soosung & Satchell, Steve E., 2010. "How loss averse are investors in financial markets?," Journal of Banking & Finance, Elsevier, vol. 34(10), pages 2425-2438, October.
Full references (including those not matched with items on IDEAS)

Citations

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:ihs:ihsesp:291. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Doris Szoncsitz).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.