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Consumption and portfolio choice under loss aversion and endogenous updating of the reference level
- Source :
- Management Science, 66(9), 3927-3955. INFORMS Inst.for Operations Res.and the Management Sciences, Management Science, 66(9). INFORMS Inst.for Operations Res.and the Management Sciences
- Publication Year :
- 2020
- Publisher :
- INFORMS Inst.for Operations Res.and the Management Sciences, 2020.
-
Abstract
- We explicitly derive and explore the optimal consumption and portfolio policies of a loss-averse individual who endogenously updates his or her reference level over time. We find that the individual protects current consumption by delaying painful reductions in consumption after a drop in wealth, and increasingly so with higher degrees of endogeneity. The incentive to protect current consumption is stronger with a medium wealth level than with a high or low wealth level. Furthermore, this individual adopts a conservative investment strategy in normal states and typically a more aggressive strategy in good and bad states. Endogeneity of the reference level increases overall risk-taking and generates an incentive to reduce risk exposure with age even without human capital. The welfare loss that this individual would suffer under the conventional constant relative risk aversion (CRRA) consumption and portfolio policies easily exceeds 10%. This paper was accepted by Tyler Shumway, finance.
- Subjects :
- SELECTION
DISAPPOINTMENT
Technology
Investment strategy
Strategy and Management
media_common.quotation_subject
Social Sciences
Management Science and Operations Research
DECISION-MAKING
ASSET PRICES
optimal consumption choice
01 natural sciences
endogenous reference level
Microeconomics
loss aversion
010104 statistics & probability
Prospect theory
PROSPECT-THEORY
Loss aversion
Reference level
Business & Economics
0502 economics and business
Econometrics
Economics
Deadweight loss
Endogeneity
0101 mathematics
media_common
Consumption (economics)
Rate of return
050208 finance
Science & Technology
Operations Research & Management Science
05 social sciences
prospect theory
HABIT FORMATION
LIFE-CYCLE
Management
MODEL
Incentive
optimal portfolio choice
Portfolio
REGRET THEORY
Volatility (finance)
EQUITY
Welfare
Smoothing
Subjects
Details
- Language :
- English
- ISSN :
- 15265501 and 00251909
- Volume :
- 66
- Issue :
- 9
- Database :
- OpenAIRE
- Journal :
- Management Science
- Accession number :
- edsair.doi.dedup.....d5dd1082423ce650a27282257b9d850e