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Part 2 DK
- 1. Myopic loss aversion as an solution to the equity premium puzzle Central questions •Why is the equity premium so large? • Why is anyone willing to hold bonds? Sub-questions – (will be revised, this is just a list of the important ones) • What combination of loss aversion and evalution period would benecessary to explain the historical pattern of returns? • How often would an investor have to evaluate his portfolio in order to be indifferent between the historical distribution of returns on stocks and bonds? • Is the equity premium real? •If investors have prospect theory preferences, how often would they have to evaluate their portfolios to explain the equity premium? • Which evaluation period would make investors indifferent between holding all their assets in stocks or bonds? •For an investor with this evaluation period, what combination of stocks and bonds would maximise prospective utility?
- 2. Theory behind the equity premium puzzle • Prospect theory (Kahneman & Tverksy, 1979) – Loss aversion – Mental accounting
- 4. Mental accounting • Richard Thaler (1980)
- 5. • Loss aversion + mental accounting = myopic loss aversion The combination of a very high sensitivity to losses combined with the tendency to evaluate portfolios frequently (every 12 months) provides an explanation to the size of the premium, and hence a solution to the puzzle.
Notes de l'éditeur
- The solution to the equity premium puzzle, according to Bernatiz and Thaler, is what they called myopic lossavension which consists of two findings from prosepct theory, namelay loss aversion and mental accounting. In order to fully understand how the solution to the equity premium works we need towork thourgh some theory underlying the puzzle.
- Decisions are made based on the referenc point, whoch can change with time. Find the refrence point in the equity premium case: how often would an investor have to evaluate his portfolio in order to be indifferent between the historical distibution of returns on stocks and bonds? Definition of ”reference point”: Under prospect theory, value is assigned to gains and losses rather than to final assets; also probabilities are replaced by decision weights. The value function is defined on deviations from a reference point and is normally concave for gains (implying risk aversion), commonly convex for losses (risk seeking) and is generally steeper for losses than for gains (loss aversion)