Loss Aversion, Survival and Asset Prices

This paper studies the wealth and pricing implications of loss aversion in the presence of arbitrageurs with Epstein–Zin preferences. Loss aversion affects an investor's survival prospects mainly through its effect on the investor's portfolio holdings. Loss-averse investors will be driven out of the market and do not affect long-run prices if their portfolio positions are further away from those corresponding to the log investor than arbitrageurs. In terms of wealth shares, the market selection process can be slow, but the selection force is nonetheless effective in terms of price impact, which highlights the importance of introducing preference heterogeneity in understanding asset prices.

[1]  Jon Kristian Heimdal.  Myopic Loss Aversion and the Equity Premium Puzzle , 2013 .

[2]  Dan Cao,et al.  COLLATERAL SHORTAGES, ASSET PRICE AND INVESTMENT VOLATILITY WITH HETEROGENEOUS BELIEFS , 2010 .

[3]  Muhammet Fatih Guvenen,et al.  Mismeasurement of the Elasticity of Intertemporal Substitution:The Role of Limited Stock Market Participation , 2000 .

[4]  Hongjun Yan,et al.  Natural Selection in Financial Markets: Does it Work? , 2008, Manag. Sci..

[5]  Colin Camerer,et al.  Risk and time preferences: linking experimental and household survey data from Vietnam , 2010 .

[6]  Orazio Attanasio,et al.  Intertemporal substitution, risk aversion and the Euler Equation for consumption , 1989 .

[7]  Hongjun Yan,et al.  Equilibrium Asset Prices and Investor Behavior in the Presence of Money Illusion , 2009 .

[8]  Timothy Cogley,et al.  Diverse Beliefs, Survival and the Market Price of Risk , 2009 .

[9]  N. Barberis,et al.  What Drives the Disposition Effect? An Analysis of a Long-Standing Preference-Based Explanation , 2006 .

[10]  Prospect Theory and Asset Prices , 1999 .

[11]  Fatih Guvenen,et al.  A Parsimonious Macroeconomic Model for Asset Pricing , 2009 .

[12]  Larry G. Epstein,et al.  Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis , 1991, Journal of Political Economy.

[13]  L. Summers,et al.  Noise Trader Risk in Financial Markets , 1990, Journal of Political Economy.

[14]  Jakša Cvitanić,et al.  Price impact and portfolio impact , 2010 .

[15]  Francisco Gomes,et al.  Asset Pricing with Limited Risk Sharing and Heterogeneous Agents , 2005 .

[16]  Hongjun Yan,et al.  Is Noise Trading Cancelled Out by Aggregation? , 2010, Manag. Sci..

[17]  N. Barberis,et al.  Mental Accounting, Loss Aversion, and Individual Stock Returns , 2001 .

[18]  N. Kocherlakota,et al.  The Equity Premium: It’s Still a Puzzle , 1999 .

[19]  A. Tversky,et al.  Prospect theory: an analysis of decision under risk — Source link , 2007 .

[20]  L. Hansen,et al.  Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns , 1983, Journal of Political Economy.

[21]  Suleyman Basak,et al.  Asset Pricing with Heterogeneous Beliefs , 2004 .

[22]  Lan Peter Hamen,et al.  Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models , 1982 .

[23]  Annette Vissing-Jorgensen,et al.  Limited Asset Market Participation and the Elasticity of Intertemporal Substitution , 2002, Journal of Political Economy.

[24]  Albert S. Kyle,et al.  Speculation Duopoly with Agreement to Disagree: Can Overconfidence Survive the Market Test? , 1997 .

[25]  Xavier Gabaix.  Discussion: The Loss Aversion/Narrow Framing Approach to the Equity Premium Puzzle , 2008 .

[26]  Wei Xiong,et al.  Prospect Theory and Liquidation Decisions , 2005, J. Econ. Theory.

[27]  David Easley,et al.  Heterogeneity, Selection, and Wealth Dynamics , 2010 .

[28]  J. Campbell,et al.  By Force of Habit: A Consumption‐Based Explanation of Aggregate Stock Market Behavior , 1995, Journal of Political Economy.

[29]  Sheridan Titman,et al.  Feedback and the success of irrational investors , 2006 .

[30]  A. Tversky,et al.  Advances in prospect theory: Cumulative representation of uncertainty , 1992 .

[31]  Grant R. Mcqueen,et al.  Whence GARCH? A Preference-Based Explanation for Conditional Volatility , 2003 .

[32]  R. Thaler,et al.  A Survey of Behavioral Finance , 2002 .

[33]  Frédéric Palomino,et al.  Noise trading in small markets , 1994 .

[34]  N. H. Hakansson..  Capital Growth and the Mean-Variance Approach to Portfolio Selection , 1971, Journal of Financial and Quantitative Analysis.

[35]  F. Lutz,et al.  The case for flexible exchange rates , 1954 .

[36]  E. Thorp.  OPTIMAL GAMBLING SYSTEMS FOR FAVORABLE GAMES , 1969 .

[37]  A. Alchian.  Uncertainty, Evolution, and Economic Theory , 1950, Journal of Political Economy.

[38]  R. Thaler,et al.  Individual Preferences, Monetary Gambles, and Stock Market Participation: A Case for Narrow Framing , 2006 .

[39]  Ravi Bansal,et al.  Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles , 2000 .

[40]  Liyan Yang,et al.  Prospect Theory, the Disposition Effect, and Asset Prices , 2013 .

[41]  R. Mehra,et al.  THE EQUITY PREMIUM A Puzzle , 1985 .

[42]  Emanuela Sciubba,et al.  Belief heterogeneity and survival in incomplete markets , 2012 .

[43]  Uzi Segal,et al.  First order versus second order risk aversion , 1990 .

[44]  D. Kahneman.  Maps of Bounded Rationality: Psychology for Behavioral Economics , 2003 .

[45]  Jiang Wang,et al.  Market Selection , 2017, J. Econ. Theory.

[46]  Deborah Lucas,et al.  Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing , 1993, Journal of Political Economy.

[47]  Fatih Guvenen,et al.  Reconciling Conflicting Evidence on the Elasticity of Intertemporal Substitution , 2000 .

[48]  Jiang Wang,et al.  The Price Impact and Survival of Irrational Traders , 2004 .

[49]  Scott Condie,et al.  Living with ambiguity: prices and survival when investors have heterogeneous preferences for ambiguity , 2008 .

[50]  Francisco Gomes.  Portfolio Choice and Trading Volume with Loss Averse Investors , 2003 .

[51]  L. Blume,et al.  If You're so Smart, Why Aren't You Rich? Belief Selection in Complete and Incomplete Markets , 2001 .

[52]  Prospect Theory and Market Quality , 2013 .

[53]  D. Kahneman.  Maps of Bounded Rationality , 2002 .

[54]  L. Blume,et al.  Evolution and market behavior , 1992 .

[55]  Christian Heyerdahl-Larsen,et al.  Market Selection and Welfare in a Multi-asset Economy , 2013 .

[56]  Liyan Yang,et al.  Financial Market Dynamics : Implications of Prospect Theory for Asset Prices and Trading Volume , 2010 .

[57]  Harald Uhlig,et al.  Leisure, Growth and Long Run Risk. ⁄ , 2007 .

[58]  Thomas D. Tallarini.  Risk-sensitive real business cycles☆ , 2000 .

[59]  Phyllis Woloshin.  If you're so smart, why aren't you rich? , 1986 .

[60]  J. Borovička,et al.  Heterogeneous beliefs under recursive preferences , 2009 .

[61]  David A. Hirshleifer,et al.  Limited Investor Attention and Stock Market Misreactions to Accounting Information , 2010 .

[62]  Jan Wenzelburger,et al.  On the performance of efficient portfolios , 2005 .

[63]  D. Kahneman,et al.  Timid choices and bold forecasts: a cognitive perspective on risk taking , 1993 .

[64]  Ming Huang,et al.  Preferences with Frames: A New Utility Specification that Allows for the Framing of Risks , 2007 .

[65]  Larry G. Epstein,et al.  Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework , 1989 .

[66]  Harjoat Singh Bhamra,et al.  The Effect of Introducing a Non-Redundant Derivative on the Volatility of Stock-Market Returns When Agents Differ in Risk Aversion , 2009 .

[67]  Wei Xiong,et al.  Heterogeneous Expectations and Bond Markets , 2006 .

[68]  Rui Castro,et al.  Asset Pricing in a Production Economy with Chew-Dekel Preferences , 2007 .

[69]  Arjan Berkelaar,et al.  From boom til bust: how loss aversion affects asset prices , 2009 .

[70]  L. Grüne,et al.  Asset Pricing with Loss Aversion ∗ , 2007 .

[71]  L. Summers,et al.  The Survival of Noise Traders in Financial Markets , 1988 .

[72]  Arjan Berkelaar,et al.  Optimal Portfolio Choice under Loss Aversion , 2000, Review of Economics and Statistics.

[73]  Itzhak Ben-David,et al.  Are Investors Really Reluctant to Realize their Losses? Trading Responses to Past Returns and the Disposition Effect , 2012 .

[74]  Felix Kubler,et al.  Stationary Equilibria in Asset-Pricing Models with Incomplete Markets and Collateral , 2003 .

[75]  Suleyman Basak,et al.  An Equilibrium Model with Restricted Stock Market Participation , 1997 .

[76]  Michael J. Brennan,et al.  Stock price volatility and equity premium , 2001 .

[77]  R. Thaler,et al.  Chapter 18 A survey of behavioral finance , 2003 .

[78]  John Y. Campbell,et al.  Asset Prices, Consumption, and the Business Cycle , 1998 .

[79]  Rabah Amir,et al.  Market Selection and Survival of Investment Strategies , 2001 .

[80]  Alvaro Sandroni,et al.  Market selection when markets are incomplete , 2005 .

[81]  Alvaro Sandroni,et al.  Market selection and asymmetric information , 2000 .

[82]  B. Dumas.  Two-Person Dynamic Equilibrium in the Capital Market , 1989 .

[83]  David Genesove,et al.  Loss Aversion and Seller Behaviour: Evidence from the Housing Market , 2001 .

[84]  Emanuela Sciubba,et al.  Asymmetric information and survival in financial markets , 1999 .

[85]  Thomas M. Arnold.  Stocks as Lotteries: The Implications of Probability Weighting for Security Prices , 2009 .

[86]  L. Blume,et al.  Market Selection and Asset Pricing , 2009 .

[87]  Burton Hollifield,et al.  An Examination of Heterogeneous Beliefs with a Short Sale Constraint , 2002 .

[88]  David A. Chapman,et al.  First-Order Risk Aversion, Heterogeneity, and Asset Market Outcomes ∗ , 2009 .

[89]  Alvaro Sandroni.  Do markets favor agents able to make accurate predictions , 2000 .

[90]  R. Lucas.  ASSET PRICES IN AN EXCHANGE ECONOMY , 1978 .

[91]  Filippo Massari.  Price Dynamics and Market Selection in Small and Large Economies , 2014 .