Portfolio choice under loss aversion and diminishing sensitivity: a theoretical extension

Hongxia Wang, Duc Khuong Nguyen, Xiong Xiong and Peng-Fei Dai ()
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Hongxia Wang: Nanjing University of Finance and Economics
Xiong Xiong: Tianjin University
Peng-Fei Dai: East China University of Science and Technology

Annals of Operations Research, 2025, vol. 347, issue 1, No 4, 69-85

Abstract: Abstract This article provides some analytical proofs for the effects of loss aversion and diminishing sensitivity on portfolio choice. We use the performance index (Omega ratio) of return distribution to characterize the threshold value that determines non-zero investment in the risky asset and show the impact of stochastic improvement of risky return on the threshold. We propose the measure of greater diminishing sensitivity and examine the loss aversion characterizations for large and small stakes. Moreover, we demonstrate that diminishing sensitivity and loss aversion may make opposite predictions on willingness to invest in the risky asset. Specifically, although loss aversion decreases the investment in the risky asset, diminishing sensitivity in the loss domain will predict the opposite.

Keywords: Portfolio choice; Loss aversion; Diminishing sensitivity; Participation puzzle (search for similar items in EconPapers)
JEL-codes: D81 G11 (search for similar items in EconPapers)
Date: 2025
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DOI: 10.1007/s10479-022-05081-9

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