The Individually Accepted Loss

Erick Rengifo, Emanuela Trifan and Rossen Trendafilov
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Erick Rengifo: Fordham University
Emanuela Trifan: Bayerngas Energy
Rossen Trendafilov: Truman State University

Fordham Economics Discussion Paper Series from Fordham University, Department of Economics

Abstract: This paper proposes a new, individual measure of market risk, denoted as the individually acceptable loss (IAL). This measure can be used by portfolio managers in order to better meet the individual profiles of their non-professional clients, including phsychological traits. It can be easily assessed from general subjective and objective parameters. We formally define the IAL of loss averse investors, who narrowly frame financial investments, and are sensitive to the past performance of their risky portfolio. This individual risk measue is applied to the classic portfolio optimization framework in order to derive the optimal wealth allocation among different financial assets. our empirical results suggest that previous optimization relying on a portfolio-exogenous VaR-formulation, underestimates the aversion of individual investors towards financial losses.

Keywords: market risk; prospect theory; loss aversion; capital allocation; Value-at-Risk. (search for similar items in EconPapers)
JEL-codes: C32 C35 G10 (search for similar items in EconPapers)
Date: 2014
New Economics Papers: this item is included in nep-cfn, nep-rmg and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:frd:wpaper:dp2014-04

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