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Optimal Portfolio Choice under Loss Aversion

Arjan B. Berkelaar¹; Roy Kouwenberg^2,3; Thierry Post³

¹ World Bank · ² Asian Institute of Technology · ³ Erasmus University Rotterdam

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.

DOI

10.1162/0034653043125167

Volume

86 (4)

Pages

973-987

Language

en

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BibTeX

Sources

crossref openalex