Performance measurement with loss aversion

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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

Publication date: September 1, 2006

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