Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/260596 
Year of Publication: 
2022
Series/Report no.: 
IHS Working Paper No. 42
Publisher: 
Institut für Höhere Studien - Institute for Advanced Studies (IHS), Vienna
Abstract: 
We study the asset allocation of an investor with prospect theory (PT) preferences. First, we solve analytically the two-asset problem of the PT investor for one risk-free and one risky asset and find that loss aversion and the reference return affect differently less ambitious investors and more ambitious investors. Second, we empirically investigate the performance of a PT portfolio when diversifying among a stock market index, a government bond and gold, in Europe and the US. We focus on investors with PT preferences under different scenarios regarding the reference return and the degree of loss aversion and compare their portfolio performance with the performance of investors under CVaR, risk neutral, linear loss averse and in particular mean-variance (MV) preferences. We find that, in the US, PT portfolios significantly outperform (in terms of returns) mean-variance portfolios in the majority of cases. Also with respect to riskadjusted performance, PT investment outperforms MV investment in the US. Similar results, however, can not be observed in Europe. Finally, we analyze asymmetric effects along economic uncertainty and observe that PT investment leads to higher returns than MV investment in times of larger economic uncertainty, especially in the US.
Subjects: 
prospect theory
loss aversion
portfolio allocation
mean-variance portfolios
investment strategy
JEL: 
D81
G02
G11
G15
Creative Commons License: 
cc-by Logo
Document Type: 
Working Paper

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