Why stocks may disappoint |
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| Institution: | 1. DCU Business School, Dublin City University, Ireland;2. ESC Rennes School of Business, France;3. Queen''s Management School, Queen''s University Belfast, UK;1. Department of Economics and Social Sciences, Faculty of Economics “G. Fuá”, Polytechnic University of Marche, Piazzale Martelli 8, 60121 Ancona, Italy;2. Department of Economics, New York University, 269 Mercer Street, NY 10003, New York, USA;1. Mercer University, 3001 Mercer University Drive, Atlanta, GA 30341, United States;2. California State University — Northridge, 18111 Nordhoff St, Northridge, CA 91330, United States;3. University of Wisconsin — Whitewater, 809 W. Starin Road, Whitewater, WI 53190, United States |
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| Abstract: | We provide a formal treatment of both static and dynamic portfolio choice using the Disappointment Aversion preferences of Gul (1991. Econometrica 59(3), 667–686), which imply asymmetric aversion to gains versus losses. Our dynamic formulation nests the standard CRRA asset allocation problem as a special case. Using realistic data generating processes, we find reasonable equity portfolio allocations for disappointment averse investors with utility functions exhibiting low curvature. Moderate variation in parameters can robustly generate substantial cross-sectional variation in portfolio holdings, including optimal non-participation in the stock market. |
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