title: Asset allocation under disappointment aversion
Creators: name: Xie, Yuxin
Publisher: name: University of Liverpool Repository
Year: 2015

description: The present thesis examines one of the non–standard preferences, the theory of disappointment aversion (DA) from Gul (1991), within an asset allocation problem. Related to the area of decision–making under risk, it sheds light on: (i) at the global level, how the risk exposure reduces quantitatively in the presence of disappointment aversion; (ii) given the empirical data, what are the plausible levels of disappointment aversion around different financial markets; and (iii) how disappointment aversion interacts with both inherent risk attitudes (i.e., risk aversion, subjective probability weighting and cultural dimensions) and environmental stimuli (i.e., pleasant or unpleasant odours). In Chapter 2, drawing upon the seminal study of Ang et al. (2005), we incorporate disappointment aversion (that is, extra aversion to outcomes that are worse than prior expectations) within a simple theoretical portfolio choice model. Based on the results of this model, we then empirically address the portfolio allocation problem of an investor who chooses between a risky and a risk–free asset using international data from 19 countries. Our findings strongly support the view that disappointment aversion leads investors to reduce their exposure to the stock market (i.e., disappointment aversion significantly depresses the portfolio weights on equities in all cases considered). Overall, our study shows that, in addition to risk aversion, disappointment aversion plays an important role in explaining the equity premium puzzle around the world. In Chapter 3, we investigate investors’ asset allocation when their utility consists of wealth utility and disappointment aversion utility in which gains and losses are calculated with respect to the expected wealth. We show that optimal investment proportions increase when disappointment aversion on the assets decreases, and that disappointment aversion increases when expected excess returns increase. When decreasing absolute risk aversion holds, disappointment aversion increase with wealth, which is supported by our empirical results with asset allocations in pension funds of 35 OECD countries. We also find that individualism is positively related to disappointment aversion. These results indicate that the overconfidence represented by their individualism leads to more disappointment when losses occur. Chapter 4 aims to investigate the role of odours on DA in a monetary gamble task. We elicited the degree of DA based on an experimental procedure similar to Sokol-Hessner et al. (2009, 2013). Our study shows for the first time that unpleasant odours increase DA in a monetary gamble task. Such odour–related variations in individual DA were associated with hedonic evaluations of odours but not with odour intensity. Increased disappointment aversion while perceiving an unpleasant odour suggests a dynamic adjustment of aversion to losses. Given that odours are biological signals of hazards, such adjustment of disappointment aversion may have adaptive value in situations entailing threat or danger. Chapter 5 concludes this thesis and points out further directions.