Myopic loss aversion,reference point,and money illusion |
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Authors: | Xue Dong He Xun Yu Zhou |
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Affiliation: | 1. Department of IEOR , Columbia University , 316 Mudd Building, 500 W. 120th Street, 10027 , New York , NY , USA xh2140@columbia.edu;3. Mathematical Institute and Oxford–Man Institute of Quantitative Finance , The University of Oxford , Oxford , UK;4. Department of Systems Engineering and Engineering Management , Chinese University of Hong Kong , Shatin , Hong Kong |
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Abstract: | We use the portfolio selection model presented in He and Zhou [Manage. Sci., 2011, 57, 315–331] and the NYSE equity and US treasury bond returns for the period 1926–1990 to revisit Benartzi and Thaler’s myopic loss aversion theory. Through an extensive empirical study, we find that in addition to the agent’s loss aversion and evaluation period, his reference point also has a significant effect on optimal asset allocation. We demonstrate that the agent’s optimal allocation to equities is consistent with market observation when he has reasonable values of degree of loss aversion, evaluation period and reference point. We also find that the optimal allocation to equities is sensitive to these parameters. We then examine the implications of money illusion for asset allocation. Finally, we extend the model to a dynamic setting. |
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Keywords: | Myopic loss aversion Cumulative prospect theory (CPT) Evaluation period Reference point Money illusion Portfolio selection |
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