Optimal consumption and portfolio choice with loss aversion

Arbeitspapier

This paper analyses the consumption-investment problem of a loss averse investor equipped with s-shaped utility over consumption relative to a time-varying reference level. Optimal consumption exceeds the reference level in good times and descend to the subsistence level in bad times. Accordingly, the optimal portfolio is dominated by a mean-variance component in good times and rebalanced more aggressively toward stocks in bad times. This consumption-investment strategy contrasts with customary portfolio theory and is consistent with several recent stylized facts about investors' behaviour. I also analyse the joint effect of loss aversion and persistence of the reference level on optimal choices. Finally, the strategy of the loss averse investor outperforms the conventional Merton-style strategies in bad times, but tend to be dominated by the conventional strategies in good times.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: SAFE Working Paper ; No. 130

Classification and Topics

• Classification: Wirtschaft ; Portfolio Choice; Investment Decisions ; Asset Pricing; Trading Volume; Bond Interest Rates
• Subject: Loss-aversion ; Habit-formation ; Consumption-portfolio choice

Contributors, Location and Time

• Event: Geistige Schöpfung
• (who): Curatola, Giuliano
• Event: Veröffentlichung
• (who): Goethe University Frankfurt, SAFE - Sustainable Architecture for Finance in Europe
• (where): Frankfurt a. M.
• (when): 2016

Further information

• DOI: doi:10.2139/ssrn.2749498
• Handle: http://hdl.handle.net/10419/129620
• URN: urn:nbn:de:hebis:30:3-395871
• Last update: 10.03.2025, 11:43 AM CET