Study On Long Term Asset Allocation Based On Loss Aversion

Merton said that the kernel of financial is to study how economic agents utilize and allocate resource across space and time under uncertain condition. In essence, financial decision is mainly affected by time and uncertainty. With the emerging of behavioral finance, people were aware that besides time and uncertainty, behavioral preference should be very important for economic decision. So it's inevitable that behavioral preference is introduced into asset allocation.Now, pension funds are the largest institute investor in the world. With the aged era, the growing importance of pension funds has boosted the need for methodologically sound principles for asset allocation, because long-term asset allocation is the most important determinant of the pension funds performance. Safety is the fundamental of pension funds, so it means that investors extremely averse to the loss of wealth. Therefore, research of long-term asset allocation under loss aversion is important and significance to conciliate contravention between safety and performance of pension funds.Experimental studies of China stock market show that investors are risk aversion for gains and risk loving for losses in bull period, but risk aversion for losses in bear period. The result is inconsistent with K & T prospect theory investors being risk aversion for losses. In the paper, a logarithm loss aversion utility is proposed to character investors'psychogenic behavior. The feature is that investors are risk loving for small losses and risk aversion for large losses.Curvature parameters of K&T loss aversion utility should not be equal and the magnitude of loss aversion parameters is conclude in theory under local equilibrium of one period asset allocation. Experimental results of excess return of China capital market consist with theoretical results. In contrast to many traditional continuous-time analyses involving utility functions, downside risk model results in additional risk taking behavior both in situations of under-funding and over-funding. That accords with loss aversion of prospect theory. Compared with linear shortfall as a risk measure, squared shortfall induces less extreme-risk allocations for surplus values not too close to 0. Using squared shortfall as a risk measure ensures a smoother investment policy than with linear shortfall.Long-term asset allocation programming model with interest rate term-structure and guarantee is derived closed-form solutions under loss aversion by introducing pricing kernel and extend martingale method of Cox&Huang. Volatility of interest rate has no effect on ratio of stock under myopic asset allocation, so risk of interest ratecan be hedged by cash and bond. But impact of interest rate on asset allocation attenuates in hyperbolic way when the plan horizon comes near.