Loss Aversion with a State-Dependent Reference Point

Enrico De Giorgi () and Thierry Post ()
Additional contact information
Thierry Post: Graduate School of Business, Koç University, 34450 Istanbul-Sar{\i}yer, Turkey

Management Science, 2011, vol. 57, issue 6, 1094-1110

Abstract: This study investigates reference-dependent choice with a stochastic, state-dependent reference point. The optimal reference-dependent solution equals the optimal consumption solution (no loss aversion) if the reference point is selected fully endogenously. Given that loss aversion is widespread, we conclude that the reference point generally includes an important exogenously fixed component. We develop a choice model in which adjustment costs can cause stickiness relative to an initial, exogenous reference point. Using historical U.S. investment benchmark data, we show that this model is consistent with diversification across bonds and stocks for a wide range of evaluation horizons, despite the historically high-risk premium of stocks compared to bonds. This paper was accepted by Peter Wakker, decision analysis.

Keywords: behavioral finance; asset pricing; equity premium puzzle; reference-dependent preferences; loss aversion; stochastic reference point (search for similar items in EconPapers)
Date: 2011
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (25)

Downloads: (external link)
http://dx.doi.org/10.1287/mnsc.1110.1338 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:57:y:2011:i:6:p:1094-1110

Access Statistics for this article

More articles in Management Science from INFORMS Contact information at EDIRC.
Bibliographic data for series maintained by Chris Asher ().