Asset Pricing with Loss Aversion

L. Grüne, W. Semmler: Asset Pricing with Loss Aversion
Journal of Economic Dynamics and Control 32, 3253 - 3274, 2008

Smart-Link: http://www.elsevier.com/locate/jedc
DOI: 10.1016/j.jedc.2008.01.002
Keywords: behavioral finance; loss aversion; stochastic growth models. asset Pricing and stochastic dynamic programming
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Abstract:

The use of standard preferences for asset pricing has not been very successful in matching asset price characteristics, such as therisk-free interest rate, equity premium and the Sharpe ratio, to time seriesdata. Behavioral finance has recently proposed more realistic preferences such as those with loss aversion. Research is starting to explore theimplications of behaviorally founded preferences for asset pricecharacteristics. Encouraged by some studies of S. Benartzi and R. H. Thaler [Q. J. Econ. 110, No. 1, 73--92 (1995; Zbl 0829.90040)] and N. Barberis, M. Huang and T. Santos [Q. J. Econ. 116, No. 1, 1--53 (2001; Zbl 0979.91025)] we study asset pricing with loss aversion in aproduction economy. Here, we employ a stochastic growth model and use a stochastic version of a dynamic programming method with an adaptive grid scheme to compute the above mentioned asset price characteristics of a model with loss aversion in preferences. As our results show using loss aversion we get considerably better results than one usually obtains from pureconsumption-based asset pricing models including the habit formation Variant.

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