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Performance measurement with loss aversion

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Salmon, Mark H., Gemmill, Gordon and Hwang, Soosung (2005) Performance measurement with loss aversion. Working Paper. Coventry: Warwick Business School, Financial Econometrics Research Centre. Working papers (Warwick Business School. Financial Econometrics Research Centre) (No.05/16).

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Official URL: http://www2.warwick.ac.uk/fac/soc/wbs/research/wfr...

Abstract

We examine a simple measure of portfolio performance based on prospect theory, which captures not only risk and return but also reflects differential aversion to upside and downside risk. The measure we propose is a ratio of gains to losses, with the gains and losses weighted (if desired) to reflect risk-aversion for gains and risk-seeking for losses. It can also be interpreted as the weighted ratio of the value of a call option to a put option, with the benchmark as the exercise price. When applying the loss-aversion performance measure to closed-end funds, we find that it gives significantly different rankings from those of conventional measures (such as the Sharpe ratio, Jensen’s alpha, the Sortino ratio, and the Higher Moment measure), and gives the expected signs for the odd and even moments of tracking errors. However, loss-aversion performance is not more closely related to discounts on funds than are the conventional performance measures, so we have not found evidence that loss-aversion attracts investors to particular funds in the short-term.

Item Type:

Working or Discussion Paper (Working Paper)

Subjects:

H Social Sciences > HG Finance

Divisions:

Faculty of Social Sciences > Warwick Business School > Financial Econometrics Research Centre
Faculty of Social Sciences > Warwick Business School

Library of Congress Subject Headings (LCSH):

Portfolio management, Investment analysis, Loss aversion, Utility theory, Closed-end funds

Series Name:

Working papers (Warwick Business School. Financial Econometrics Research Centre)

Publisher:

Warwick Business School, Financial Econometrics Research Centre

Place of Publication:

Coventry

Official Date:

4 July 2005

Dates:

Date	Event
4 July 2005	Published

Number:

No.05/16

Number of Pages:

Institution:

University of Warwick

Status:

Not Peer Reviewed

Access rights to Published version:

Open Access

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