Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/32078 
Year of Publication: 
2006
Series/Report no.: 
Darmstadt Discussion Papers in Economics No. 180
Publisher: 
Technische Universität Darmstadt, Department of Law and Economics, Darmstadt
Abstract: 
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.
Subjects: 
prospect theory
loss aversion
capital allocation
Value-at-Risk
portfolio evaluation
JEL: 
C32
C35
G10
Document Type: 
Working Paper

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