Optimal asset allocation under quadratic loss aversion

Arbeitspapier

We study the asset allocation of a quadratic loss-averse (QLA) investor and derive conditions under which the QLA problem is equivalent to the mean-variance (MV) and conditional value-at-risk (CVaR) problems. Then we solve analytically the two-asset problem of the QLA investor for a risk-free and a risky asset. We find that the optimal QLA investment in the risky asset is finite, strictly positive and is minimal with respect to the reference point for a value strictly larger than the risk-free rate. Finally, we implement the trading strategy of a QLA investor who reallocates her portfolio on a monthly basis using 13 EU and US assets. We find that QLA portfolios (mostly) outperform MV and CVaR portfolios and that incorporating a conservative dynamic update of the QLA parameters improves the performance of QLA portfolios. Compared with linear loss-averse portfolios, QLA portfolios display significantly less risk but they also yield lower returns.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Reihe Ökonomie / Economics Series ; No. 291

Classification and Topics

• Classification: Wirtschaft ; Criteria for Decision-Making under Risk and Uncertainty ; Portfolio Choice; Investment Decisions ; International Financial Markets ; Investment Banking; Venture Capital; Brokerage; Ratings and Ratings Agencies
• Subject: quadratic loss aversion ; prospect theory ; portfolio optimization ; MV and CVaR portfolios ; investment strategy

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Fortin, Ines ; Hlouskova, Jaroslava
• Event: Veröffentlichung
• (who): Institute for Advanced Studies (IHS)
• (where): Vienna
• (when): 2012

Further information

• Handle: http://hdl.handle.net/10419/68521
• Last update: 10.03.2025, 11:43 AM CET