Downside loss aversion: Winner or loser?

Ines Fortin and Jaroslava Hlouskova

Mathematical Methods of Operations Research, 2015, vol. 81, issue 2, 233 pages

Abstract: We study the asset allocation of a quadratic loss-averse (QLA) investor. First, we derive conditions under which the QLA problem is equivalent to the mean-variance (MV) and conditional value-at-risk (CVaR) problems. Then we solve analytically the two-asset problem of the QLA investor for one risk-free and one risky asset. We find that the optimal QLA investment in the risky asset is finite, strictly positive, and minimal with respect to the reference point for a value strictly larger than the risk-free rate. Finally, we implement the trading strategy of a QLA investor who reallocates her portfolio on a monthly basis using 13 EU and 13 US assets. Using risk-adjusted performance measures that do not target specific types of utility we find that QLA portfolios mostly outperform MV and CVaR portfolios; and that incorporating a conservative dynamic update of the QLA parameters, which is based on the historical patterns of bull and bear markets, improves the performance of QLA portfolios. Compared with linear loss-averse portfolios, QLA portfolios display significantly less risk but they also yield lower returns. Copyright Springer-Verlag Berlin Heidelberg 2015

Keywords: Quadratic/downside loss aversion; Portfolio optimization; MV portfolios; CVaR portfolios; Investment strategy (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (4)

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DOI: 10.1007/s00186-015-0493-1

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