Investors Facing Risk: Loss Aversion and Wealth Allocation Between Risky and Risk-Free Assets

Arbeitspapier

This paper studies the impact of loss aversion on decisions regarding the allocation of wealth between risky and risk-free assets. We use a Value-at-Risk portfolio model with endogenous desired risk levels that are individually determined in an extended prospect theory framework. This framework allows for the distinction between gains and losses with respect to a subjective reference point as in the original prospect theory, but also for the influence of past performance on the current perception of the risky portfolio value. We show how the portfolio evaluation frequency impacts investor decisions and attitudes when facing financial losses and analyze the role of past gains and losses in the current wealth allocation. The perceived portfolio value exhibits distinct evolutions in two frequency segments delimitated by what we consider to be the optimal evaluation horizon of one year. Our empirical results suggest that previous research relying on VaR underestimates the aversion of real individual investors to financial losses.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Darmstadt Discussion Papers in Economics ; No. 180

Classification and Topics

• Classification: Wirtschaft ; Multiple or Simultaneous Equation Models: Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models ; Multiple or Simultaneous Equation Models: Discrete Regression and Qualitative Choice Models; Discrete Regressors; Proportions ; General Financial Markets: General (includes Measurement and Data)
• Subject: prospect theory ; loss aversion ; capital allocation ; Value-at-Risk ; portfolio evaluation

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Rengifo, Erick W. ; Trifan, Emanuela
• Event: Veröffentlichung
• (who): Technische Universität Darmstadt, Department of Law and Economics
• (where): Darmstadt
• (when): 2006

Further information

• Handle: http://hdl.handle.net/10419/32078
• Last update: 10.03.2025, 11:43 AM CET