Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/129620
Authors: 
Curatola, Giuliano
Year of Publication: 
2016
Series/Report no.: 
SAFE Working Paper Series 130
Abstract: 
This paper analyses the consumption-investment problem of a loss averse investor equipped with s-shaped utility over consumption relative to a time-varying reference level. Optimal consumption exceeds the reference level in good times and descend to the subsistence level in bad times. Accordingly, the optimal portfolio is dominated by a mean-variance component in good times and rebalanced more aggressively toward stocks in bad times. This consumption-investment strategy contrasts with customary portfolio theory and is consistent with several recent stylized facts about investors' behaviour. I also analyse the joint effect of loss aversion and persistence of the reference level on optimal choices. Finally, the strategy of the loss averse investor outperforms the conventional Merton-style strategies in bad times, but tend to be dominated by the conventional strategies in good times.
Subjects: 
Loss-aversion
Habit-formation
Consumption-portfolio choice
JEL: 
G11
G12
Document Type: 
Working Paper

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