Myopic Loss Aversion, Asymmetric Correlations, and the Home Bias

Abstract

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