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Loss Aversion with a State-dependent Reference Point

Enrico De Giorgi & Thierry Post

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abstract This study investigates reference-dependent choice with a stochastic, state-dependent reference point. The optimal reference-dependent solution equals the optimal consumption solution (no loss aversion) if the reference point is selected fully endogenously. Given that loss aversion is widespread, we conclude that the reference point generally includes an important exogenously fixed component. We develop a choice model in which adjustment costs can cause stickiness relative to an initial, exogenous reference point. Using historical U.S. investment benchmark data, we show that this model is consistent with diversification across bonds and stocks for a wide range of evaluation horizons, despite the historically high-risk premium of stocks compared to bonds.
   
type journal paper
   
keywords
   
project Applying Recent Developments in Computational Statistics to Behavioral Asset Pricing and Portfolio Selection
language English
kind of paper journal article
date of appearance 29-4-2011
journal Management Science
publisher Informs (Hanover, MD)
ISSN 0025-1909
ISSN (online) 1526-5501
DOI 10.1287/mnsc.1110.1338
volume of journal 57
number of issue 6
page(s) 1094-1110
review double-blind review
   
citation De Giorgi, E., & Post, T. (2011). Loss Aversion with a State-dependent Reference Point. Management Science, 57(6), 1094-1110, DOI:10.1287/mnsc.1110.1338.