Loss Aversion with a State-dependent Reference Point
Journal
Management Science
ISSN
0025-1909
ISSN-Digital
1526-5501
Type
journal article
Date Issued
2011-04-29
Author(s)
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.
Language
English
HSG Classification
contribution to scientific community
Refereed
Yes
Publisher
Informs
Publisher place
Hanover, MD
Volume
57
Number
6
Start page
1094
End page
1110
Pages
17
Subject(s)
Eprints ID
162907