Gemmill, Gordon, Hwang, Soosung and Salmon, Mark H. (Mark Howard), 1949- (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).

Preview

PDF WRAP_Gemmill_fwp05-08.pdf - Requires a PDF viewer such as GSview, Xpdf or Adobe Acrobat Reader Download (632Kb)

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, Closed-end funds, Utility theory
Series Name:	Working papers (Warwick Business School. Financial Econometrics Research Centre)
Publisher:	Warwick Business School, Financial Econometrics Research Centre
Place of Publication:	Coventry
Date:	4 July 2005
Number:	No.05-
Number of Pages:	44
Status:	Not Peer Reviewed
Access rights to Published version:	Open Access
References:	Amenc, N. and V. Le Sourd, 2005, “Rating the Ratings”, Edhec Risk and Management Centre, Lille. Ang, A., G. Bekeart, and J. Liu, 2004, "Why Stocks May Disappoint," forthcoming, Journal of Financial Economics. Artzner, P, 1999, Coherent Measures of Risk, Mathematical Finance 9(3), 203-228. Barberis, N., M. Huang, and T. Santos, 2001, "Prospect Theory and Asset Prices," Quarterly Journal of Economics, 116(1), 1-53. Benartzi, S. and R. H. Thaler, 1995, "Myopic Loss Aversion and the Equity Premium Puzzle", Quarterly Journal of Economics, 110(1), 73-92. Burnes, J., Neilson, W., 2002. A Further Examination of Cumulative Prospect Theory Parameterizations. Journal of Risk and Uncertainty 24, 31-46. Carhart, Mark M., 1997, "On Persistence In Mutual Fund Performance," Journal of Finance, 52(1), 57-82. Chay, J. B. and C. Trzcinka, 1999, "Managerial Performance and the Cross-sectional Pricing of Closed-end Funds, Journal of Financial Economics 52, 379-408. Chen, Z., and P. J. Knez, 1996. Portfolio Performance Measurement: Theory and Applications, Review of Financial Studies 9(2), 511-555. Clarke, R. G., S. Krase, and M. Statman, 1994, “Tracking Errors, Regret, and Tactical Asset Allocation”, Journal of Portfolio Management, Spring, 16-24. Connor, G., and R. Korajczyk, 1986. Performance Measurement with the Arbitrage Pricing Theory: A new Framework for Analysis, Journal of Financial Economics 15, 374-394. Cumby, R., and J. Glen, 1990. Evaluating the performance of international mutual funds, Journal of Finance 45, 497-521. DeLong, J. B., A. Shleifer, L. H. Summers, and R. J. Waldmann, 1990, "Positive-Feedback Investment Strategies and Destabilizing Rational Speculation," Journal of Finance 45(2), 374-397. Dimson, E. and C. Minio-Kozerski, 1999, Closed-End-Funds: A Survey, Financial Markets, Institutions and Instruments 8(2), 1-41. Embrechts, P., Klüppelberg, C., and T. Mikosch, 1997, Modelling Extremal Events for Insurance and Finance, Springer, Berlin. Fielding, David and Livio Stracca, 2003, “Myopic Loss Aversion, Disappointment Aversion, and the Equity Premium Puzzle”, working paper no. 203, European Central Bank, Frankfurt. Fishburn, Peter C, 1977. "Mean-Risk Analysis with Risk Associated with Below-Target Returns," American Economic Review, Vol. 67 (2) pp. 116-26. Fishburn, P. C. and G. A. Kochenberger, 1979, "Concepts, Theory, Techniques; Twopiece Von Neumann-Morgenstern Utility Functions," Decision Sciences, 10, 503-518. Gemmill, G. and Thomas, D., 2002. Noise Trading, Costly Arbitrage and Asset Prices: Evidence from Closed-End Funds, Journal of Finance 57, 2571-2594. Glosten, L. R. and R. Jagannathan, 1994. A Contingent Claim Approach to Performance Evaluation, Journal of Empirical Finance 1, 133-160. Grinblatt, M., and S. Titman, 1989. Portfolio Performance Evaluation: Old Issues and New Insights, Review of Financial Studies 2(3), 393-421. Grinblatt, M., and S. Titman, 1994. A study of Monthly Mutual Fund Returns and Performance Evaluation Techniques, Journal of Financial and Quantitative Analysis 29(3), 419-444. Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Vol. 59 (3) pp. 667-86. Gupta, Francis, Robertus Prajogi and Eric Stubbs, 1999. The Information Ratio And Performance, Journal of Portfolio Management, 26(1), 33-39. Hwang, S. and M. Salmon, 2002, An Analysis of Performance Measures using Copulae, in J. Knight and S. Satchell eds., Performance Measurement in Finance: Firms, Funds and Managers, Butterworth-Heinemann, London." Hwang, S., and S. Satchell, 1998. Evaluation of Mutual Fund Performance in Emerging Markets, Emerging Markets Quarterly 2(3), 39-50. Hwang, S., and S. E. Satchell, 2005. The Magnitude of Loss Aversion Parameters in Financial Markets, Unpublished manuscript, Cass Business School. Jensen, M, 1968. The performance of mutual funds in the period 1945-1964, Journal of Finance 23, 389-416. Kahneman, D. and A. Tversky, 1979, "Prospect Theory: An Analysis of Decision Under Risk," Econometrica 47, 263-291. Keating, C. and W. F. Shadwick, 2002. A Universal Performance Measure, Journal of Performance Measurement 6(3), 59–84. Lee, W., 1998, “Return and Risk Characteristics of Tactical Asset Allocation under Imperfect Information”, Journal of Portfolio Management, Fall, 61-70. Lee, M. C., A. Shleifer, and R. Thaler, 1991, “Investor Sentiment and the Closed-End Fund Puzzle”, Journal of Finance 46(1), 75-109. Lehmann, B., and D. Modest, 1987. Mutual fund performance evaluation: A comparison of benchmarks and benchmark comparisons, Journal of Finance 42, 233-265. Levy, M., and H. Levy, 2002. Prospect Theory: Much Ado About Nothing?, Management Science 48(10), 1334-1349. Margrabe, W., 1978, “The Value of an Option to Exchange One Asset for Another”, Journal of Finance 33, 177-86. Roll, R., 1992, “A Mean/Variance Analysis of Tracking Error,” Journal of Portfolio Management, 13-22. Pope, P. and P. K. Yadav, 1994, Discovering Error in Tracking Error, Journal of Portfolio Management (Winter 1994), 27-32. Rudolf, M., H. Wolter, and H. Zimmermann, 1999, “A Linear Model for Tracking Error Minimization,” Journal of Banking and Finance 23, 85-103. Sharpe, W., 1966. Mutual Fund Performance, Journal of Business 39, 119-138. Sortino, F. and Van der Meer (1991), Downside risk, Journal of Portfolio Management, 27-31. Thaler, R. and E. Johnson (1990), "Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice," Management Science 36, 643-660. Treynor, J., 1965. How to Rate Management of Investment Funds, Harvard Business Review 43, 63-75. Treynor, J., and K. Mazuy, 1966. Can Mutual Funds Outguess the Market?, Harvard Business Review 44, 131-136. Tversky, A. and D. Kahneman, 1992, "Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty 5, 297-323. Wermers, R., 1996, "Momentum Investment Strategies of Mutual Funds, Performance Persistence, and Survivorship Bias. Unpublished working paper, University of Colorado at Boulder. Zweig, M. E., 1973, “An Investor Expectations Stock Price Predictive Model Using Closed-End Fund Premiums’, Journal of Finance 28, 67-87.
URI:	http://wrap.warwick.ac.uk/id/eprint/1774

Request changes to a record

Actions (login required)

View Item