Myopic Loss Aversion, Asymmetric Correlations, and the Home Bias

Myopic loss aversion has been used to explain why a high equity premium might be consistent with plausible levels of risk aversion. The intuition is that it plays the role of high risk aversion in portfolio choice. But if so, should these agents not perceive larger gains from international diversification than standard preference agents with realistic levels of risk aversion? They might not because stock market returns are asymmetrically correlated. We analyze the portfolio problem of a myopic loss averse investor who has to choose between home and foreign equities in the presence of asymmetrically correlated returns. Perhaps surprisingly, depending on the horizon, this investor behaves similarly to one with standard preferences in the context of the home bias puzzlemyopic loss aversion, home bias, asymmetric correlations, equity premium puzzle

The dynamics of global financial crises

Thesis (S.M.)--Massachusetts Institute of Technology, Sloan School of Management, Operations Research Center, 2002.Includes bibliographical references (p. 57-58).This thesis presents a Markov chain model of the transmission of financial crises. Using bilateral trade data and a measure of exchange market pressure, it develops a method to determine a set of transition probabilities that describe the crisis transmission dynamics. The dynamics are characterized by one month conditional crisis probabilities and the probability of a crisis occurring within one year. Calculations of the transition probabilities for a three country example suggest that minor trading partners can increase the likelihood of a crisis in the home country through their effect on major trading partners.by Kevin Amonlirdviman.S.M

Loss aversion, asymmetric market comovements, and the home bias

Loss aversion has been used to explain why a high equity premium might be consistent with plausible levels of risk aversion. The intuition is that the different utility impact of wealth gains and losses leads loss-averse investors to behave similarly to investors with high risk aversion. But if so, should these agents not perceive larger gains from international diversification than standard expected-utility preference agents with plausible levels of risk aversion? They might not, because comovements in international stock markets are asymmetric: Correlations are higher in market downturns than in upturns. This asymmetry dampens the gains from diversification relatively more for loss-averse investors. We analyze the portfolio problem of such an investor who has to choose between home and foreign equities in the presence of asymmetric comovement in returns. Perhaps surprisingly, in the context of the home bias puzzle we find that the loss-averse investors behave similarly to those with standard expected-utility preferences and plausible levels of risk aversion. We argue that preference specifications that appear to perform well with respect to the equity premium puzzle should be subjected to this "test."Stocks - Rate of return ; Risk ; Investments ; Portfolio management

Loss aversion, asymmetric market comovements, and the home bias

Loss aversion has been used to explain why a high equity premium might be consistent with plausible levels of risk aversion. The intuition is that the first-order-different utility impact of wealth gains and losses leads loss-averse investors to behave similarly to investors with high risk aversion. But if so, should those agents not perceive larger gains from international diversification than standard expected-utility investors with plausible levels of risk aversion? They might not, because comovements in international stock markets are asymmetric: correlations are higher in market downturns than in upturns. This asymmetry dampens the gains from diversification relatively more for loss-averse investors. We analyze the portfolio problem of such an investor who has to choose between home and foreign equities in the presence of asymmetric comovement in returns. Perhaps surprisingly, in the context of the home bias puzzle we find that loss-averse investors behave similarly to those with standard expected-utility preferences and plausible levels of risk aversion. We argue that preference specifications that appear to perform well with respect to the equity premium puzzle should be subjected to this "test".Loss aversion Home bias Asymmetric market comovements Equity premium puzzle

Loss Aversion, Asymmetric Market Comovements, and the Home Bias

Loss aversion has been used to explain why a high equity premium might be consistent with plausible levels of risk aversion. The intuition is that the different utility impact of wealth gains and losses leads loss-averse investors to behave similarly to investors with high risk aversion. But if so, should these agents not perceive larger gains from international diversification than standard expected-utility preference agents with plausible levels of risk aversion? They might not, because comovements in international stock markets are asymmetric: Correlations are higher in market downturns than in upturns. This asymmetry dampens the gains from diversification relatively more for loss-averse investors. We analyze the portfolio problem of such an investor who has to choose between home and foreign equities in the presence of asymmetric comovement in returns. Perhaps surprisingly, in the context of the home bias puzzle we find that the loss-averse investors behave similarly to those with standard expected-utility preferences and plausible levels of risk aversion. We argue that preference specifications that appear to perform well with respect to the equity premium puzzle should be subjected to this 'test.