Publication:
Loss aversion with a state-dependent reference point

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De Giorgi, Enrico G.

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English

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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.

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Management Science

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The Institute for Operations Research and the Management Sciences (INFORMS)

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Management, Operations research, Management science

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