Download This PaperFinancial Loss Aversion Illusion
Review of Finance, Vol. 24(2), pp. 381-413, Doi: 10.1093/rof/rfz002
53 Pages Posted: 5 Jun 2014 Last revised: 30 Oct 2020
Date Written: January 11, 2019
Abstract
We test the proposition that investors' ability to cope with financial losses is much better than they expect. In a panel survey of investors from a large bank in the UK, we ask for their subjective ratings of anticipated returns and experienced returns. The time period covered by the panel (2008-2010) is one where investors experienced frequent losses and gains in their portfolios. This period offers a unique setting to evaluate investors' hedonic experiences. We examine how the subjective ratings behave relative to expected portfolio returns and experienced portfolio returns. Loss aversion is strong for anticipated outcomes; investors are twice as sensitive to negative expected returns as to positive expected returns. However, when evaluating experienced returns, the effect diminishes by more than half and is well below commonly found loss aversion coefficients. This suggests that a large part of investors' financial loss aversion results from an affective forecasting error.
Keywords: Loss Aversion, Individual Investors, Return Expectations, Experience, Affective Forecasting Error
JEL Classification: D03, D14, D81, G02, G11
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