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Portfolio choice under loss aversion and diminishing sensitivity: a theoretical extension

Author

Listed:
  • Hongxia Wang

    (Nanjing University of Finance and Economics)

  • Duc Khuong Nguyen

    (IPAG Business School
    Vietnam National University)

  • Xiong Xiong

    (Tianjin University)

  • Peng-Fei Dai

    (East China University of Science and Technology
    Wuhan University of Technology)

Abstract

This article provides some analytical proofs for the effects of loss aversion and diminishing sensitivity on portfolio choice. We use the performance index (Omega ratio) of return distribution to characterize the threshold value that determines non-zero investment in the risky asset and show the impact of stochastic improvement of risky return on the threshold. We propose the measure of greater diminishing sensitivity and examine the loss aversion characterizations for large and small stakes. Moreover, we demonstrate that diminishing sensitivity and loss aversion may make opposite predictions on willingness to invest in the risky asset. Specifically, although loss aversion decreases the investment in the risky asset, diminishing sensitivity in the loss domain will predict the opposite.

Suggested Citation

  • Hongxia Wang & Duc Khuong Nguyen & Xiong Xiong & Peng-Fei Dai, 2025. "Portfolio choice under loss aversion and diminishing sensitivity: a theoretical extension," Annals of Operations Research, Springer, vol. 347(1), pages 69-85, April.
    • Handle: RePEc:spr:annopr:v:347:y:2025:i:1:d:10.1007_s10479-022-05081-9
    DOI: 10.1007/s10479-022-05081-9
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    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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