Performance Measurement with Loss Aversion

Mark Salmon, Gordon T Gemmill and Soosung Hwang ()

No 5173, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We examine a simple measure of portfolio performance based on prospect theory, which captures not only risk and return but also reflects differential aversion to upside and downside risk. The measure we propose is a ratio of gains to losses, with the gains and losses weighted (if desired) to reflect risk-aversion for gains and risk-seeking for losses. It can also be interpreted as the weighted ratio of the value of a call option to a put option, with the benchmark as the exercise price. When applying the loss-aversion performance measure to closed-end funds, we find that it gives significantly different rankings from those of conventional measures (such as the Sharpe ratio, Jensen's alpha, the Sortino ratio, and the Higher Moment measure), and gives the expected signs for the odd and even moments of tracking errors. However, loss-aversion performance is not more closely related to discounts on funds than are the conventional performance measures, so we have not found evidence that loss-aversion attracts investors to particular funds in the short-term.

Keywords: Performance measurement; Loss aversion; Prospect theory; Closed-end-fund puzzle (search for similar items in EconPapers)
JEL-codes: G11 G23 (search for similar items in EconPapers)
Date: 2005-08
New Economics Papers: this item is included in nep-fin and nep-fmk
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Journal Article: Performance measurement with loss aversion (2006)
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