Optimal Asset Allocation under Quadratic Loss Aversion

Fortin, Ines and Hlouskova, Jaroslava (September 2012) Optimal Asset Allocation under Quadratic Loss Aversion. IHS Economics Series 291

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Abstract or Table of Contents

Abstract: We study the asset allocation of a quadratic loss-averse (QLA) investor and derive conditions under which the QLA problem is equivalent to the mean-variance (MV) and conditional value-at-risk (CVaR) problems. Then we solve analytically thetwo-asset problem of the QLA investor for a risk-free and a risky asset. We find that the optimal QLA investment in the risky asset is finite, strictly positive and is minimal with respect to the reference point for a value strictly larger than the risk-free rate. Finally, we implement the trading strategy of a QLA investor who reallocates her portfolio on a monthly basis using 13 EU and US assets. We find that QLA portfolios (mostly) outperform MV and CVaR portfolios and that incorporating a conservative dynamic update of the QLA parameters improves the performance of QLA portfolios. Compared with linear loss-averse portfolios, QLA portfolios display significantly less risk but they also yield lower returns.;

Item Type: IHS Series
Keywords: 'Quadratic loss aversion' 'Prospect theory' 'Portfolio optimization' 'MV and CVaR portfolios' 'Investment strategy'
Classification Codes (e.g. JEL): D03, D81, G11, G15, G24
Status: Published
Date Deposited: 26 Sep 2014 10:39
Last Modified: 24 Jul 2017 18:35
URI: http://irihs.ihs.ac.at/id/eprint/2161

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