Portfolio Choice and Trading Volume with Loss‐Averse Investors

2005/03/01 by Francisco J. Gomes, Francisco Gomes · 271 citations
Economics, Econometrics and Finance · #Business #Economic theories and models #Economics #Financial Markets and Investment Strategies #Financial economics #Loss aversion #Microeconomics #Portfolio #Stochastic processes and financial applications #Volume (thermodynamics)

paper · doi:10.1086/427643

published in The Journal of Business 78(2), 675-706 (University of Chicago Press)

openalex publication_date 2005/03/01 · openalex created_date 2025/10/10 · openalex updated_date 2026/07/25

Abstract

We present a model of portfolio choice and stock trading volume with loss-averse investors. The demand function for risky assets is discontinuous and nonmonotonic: As wealth rises beyond a threshold, investors follow a generalized portfolio insurance strategy, which is consistent with the disposition effect. In addition, loss-averse investors hold no stocks unless the equity premium is quite high. The elasticity of the aggregate demand curve changes substantially, depending on the distribution of wealth across investors. In an equilibrium setting, the model generates positive correlation between trading volume and stock return volatility but suggests that this relationship is nonlinear.

Citations

• Prospect Theory: An Analysis of Decision under Risk

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