Performance measurement with loss aversion

Authors: Gemmill, Gordon¹; Hwang, Soosung²; Salmon, Mark³

Source: Journal of Asset Management, Volume 7, Number 3, September 2006 , pp. 190-207(18)

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Abstract:

This paper explains how prospect theory can be applied to fund performance, extending work by Darsinos and Satchell (Generalising Universal Performance Measures', Risk, 17(6), 80-84, 2004). It then uses data on closed-end funds in the UK to show that the resulting loss-averse performance measure (LAP) gives different rankings from those of conventional measures (such as the Sharpe ratio, Jensen's alpha, the Sortino ratio and the Higher Moment measure). Loss-averse performance has the desirable property of being negatively correlated with the volatility and kurtosis of tracking errors. It is not more closely related to discounts on funds than are conventional measures of performance, however, so no evidence is found that loss-aversion in the short-term is a factor in attracting investors to particular funds.Journal of Asset Management (2006) 7, 190-207; doi:10.1057/palgrave.jam.2240213

Document Type: Research article

DOI: http://dx.doi.org/10.1057/palgrave.jam.2240213

Affiliations: 1: 1has been Professor of Finance at the Warwick Business School since 2004. Prior to that he was a professor at the Cass Business School, London. He has wide research interests, but the current focus is on behavioural finance, credit risk and deriv 2: 2is a reader in finance at the Cass Business School. He received his PhD from Cambridge University. His research interests include behavioural finance, asset pricing and real estate finance. He worked as a fund manager and as an auditor, and has 3: 3is a professor of finance at Warwick Business School, and Director of the Financial Econometrics Research Centre and Warwick Finance Research Institute. He has been an advisor to the Bank of England for the last five years and has held visiting

Publication date: 2006-09-01