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Optimal Portfolio Choice under Loss Aversion

Author

Listed:
  • Arjan B. Berkelaar

    (World Bank)

  • Roy Kouwenberg

    (Asian Institute of Technology and Erasmus University Rotterdam)

  • Thierry Post

    (Erasmus University Rotterdam)

Abstract

This paper analyzes the optimal investment strategy for loss averse investors, assuming a complete market and general Ito processes for the asset prices. The loss-averse investor follows a partial portfolio insurance strategy. When the investor's planning horizon is short (less than 5 years), he or she considerably reduces the initial portfolio weight of stocks compared to an investor with smooth power utility. The empirical section of the paper estimates the level of loss aversion implied by historical U.S. stock market data, using a representative agent model. We find that loss aversion and risk aversion cannot be disentangled empirically. © 2004 President and Fellows of Harvard College and the Massachusetts Institute of Technology.

Suggested Citation

  • Arjan B. Berkelaar & Roy Kouwenberg & Thierry Post, 2004. "Optimal Portfolio Choice under Loss Aversion," The Review of Economics and Statistics, MIT Press, vol. 86(4), pages 973-987, November.
    • Handle: RePEc:tpr:restat:v:86:y:2004:i:4:p:973-987
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