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The market's implied loss aversion under power-log utility investor preferences

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  • Kale, Jivendra K.

Abstract

We use the equilibrium between equity-index spot and options markets, investor preferences modeled with Power-Log utility functions, and utility indifference pricing to estimate the market's implied loss aversion, and test prospect theory's and cumulative prospect theory's decreasing marginal sensitivity to losses postulate at the aggregate market level. We find that the equilibrium downside power in the Power-Log utility function is consistently and significantly negative, implying increasing marginal sensitivity and a concave utility function for losses. That contradicts prospect theory's and cumulative prospect theory's S-shaped value function at the aggregate market level.

Suggested Citation

  • Kale, Jivendra K., 2025. "The market's implied loss aversion under power-log utility investor preferences," Finance Research Letters, Elsevier, vol. 78(C).
    • Handle: RePEc:eee:finlet:v:78:y:2025:i:c:s1544612325004179
    DOI: 10.1016/j.frl.2025.107154
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    Keywords

    Behavioral finance; Power-log utility; Loss aversion; Prospect theory; Cumulative prospect theory;
    All these keywords.

    JEL classification:

    • G40 - Financial Economics - - Behavioral Finance - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General
    • E70 - Macroeconomics and Monetary Economics - - Macro-Based Behavioral Economics - - - General

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