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How Investors Face Financial Risk Loss Aversion and Wealth Allocation

  • Erick Rengifo

    (Fordham University, Department of Economics)

  • Emanuela Trifan

    (J.W. Goethe University Frankfurt am Main, Department of Economics)

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    We study how the wealth-allocation decisions and the loss aversion of non-professional investors change subject to behavioral factors. The optimal wealth assignment between risky and risk-free assets results within a VaR portfolio model, where risk is individually assessed according to an extended prospect-theory framework. We show how the past performance and the portfolio evaluation frequency impact investor behavior. Myopic loss aversion holds at different evaluation frequencies. One year is the optimal frequency at which, under practical constraints, risky holdings are maximized. Previous research using standard VaR-significance levels may underestimate the loss aversion of individual investors.

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    File URL: http://legacy.fordham.edu/images/academics/graduate_schools/gsas/economics/dp2008_01_rengifo_trifan.pdf
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    Paper provided by Fordham University, Department of Economics in its series Fordham Economics Discussion Paper Series with number dp2008-01.

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    Date of creation: 2008
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    Handle: RePEc:frd:wpaper:dp2008-01
    Contact details of provider: Web page: http://www.fordham.edu/economics/
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    1. Haigh, Michael S. & List, John A., 2002. "Do Professional Traders Exhibit Myopic Loss Aversion? An Experimental Analysis," Working Papers 28554, University of Maryland, Department of Agricultural and Resource Economics.
    2. repec:ner:tilbur:urn:nbn:nl:ui:12-73908 is not listed on IDEAS
    3. 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.
    4. 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.
    5. Nicholas Barberis & Ming Huang & Tano Santos, 2001. "Prospect Theory And Asset Prices," The Quarterly Journal of Economics, MIT Press, vol. 116(1), pages 1-53, February.
    6. Uri Gneezy & Arie Kapteyn & Jan Potters, 2002. "Evaluation Periods and Assett Prices in a Market Experiment," Working Papers 02-02, RAND Corporation Publications Department.
    7. Philippe Artzner & Freddy Delbaen & Jean-Marc Eber & David Heath, 1999. "Coherent Measures of Risk," Mathematical Finance, Wiley Blackwell, vol. 9(3), pages 203-228.
    8. Suleyman Basak & Alexander Shapiro, 1999. "Value-at-Risk Based Risk Management: Optimal Policies and Asset Prices," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-032, New York University, Leonard N. Stern School of Business-.
    9. 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.
    10. 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.
    11. 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.
    12. Campbell, Rachel & Huisman, Ronald & Koedijk, Kees, 2001. "Optimal portfolio selection in a Value-at-Risk framework," Journal of Banking & Finance, Elsevier, vol. 25(9), pages 1789-1804, September.
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