Loss aversion with a state-dependent reference point

Enrico G. De Giorgi, Thierry Post

Research output: Contribution to journalArticle

19 Citations (Scopus)

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.

Original languageEnglish
Pages (from-to)1094-1110
Number of pages17
JournalManagement Science
Volume57
Issue number6
DOIs
Publication statusPublished - Jun 2011
Externally publishedYes

Fingerprint

Loss aversion
Reference point
Benchmark
Evaluation
Stickiness
Diversification
Adjustment costs
Optimal consumption
Choice models
Risk premium

Keywords

  • Asset pricing
  • Behavioral finance
  • Equity premium puzzle
  • Loss aversion
  • Reference-dependent preferences
  • Stochastic reference point

ASJC Scopus subject areas

  • Strategy and Management
  • Management Science and Operations Research

Cite this

Loss aversion with a state-dependent reference point. / De Giorgi, Enrico G.; Post, Thierry.

In: Management Science, Vol. 57, No. 6, 06.2011, p. 1094-1110.

Research output: Contribution to journalArticle

De Giorgi, Enrico G. ; Post, Thierry. / Loss aversion with a state-dependent reference point. In: Management Science. 2011 ; Vol. 57, No. 6. pp. 1094-1110.
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