in this case. When zt≥1, there is no such problem because losses are penal-
ized at a single rate: 2.25 for zt=1, and higher than 2.25 for zt>1.
We adopt the following technique for dealing with the case of zt≤1: we
take the loss aversion component of the investor’s utility, namely
and for St=1 and a risk-free rate of Rf,t=3.86 percent, we compute E(v),
the expected loss aversion when the excess stock return is distributed as
logRt+ 1 – logRfN(0.06, 0.2^2 ),
a good approximation to the historical distribution of the excess stock re-
turn. We then compute the quantity for which an investor with utility
function
would have exactly the same expected loss aversion for this distribution of
the excess stock return, again with St=1. This λis our measure of the in-
vestor’s effective loss aversion for any particular zt<1.
vX S
SR R
RR
RR
RR
tt
tt ft
tft
tft
tft
(,)
()
()
for
,
,
,
,
+
+
+
+
+
=
−
−
≥
<
1
1
1
1
λSt 1
λ
vX S z
SR SR
SzR R SR zR
RzR
ttt RzR
tt tft
ttft ft t t t ft
ttft
ttft
(,,)
()( )
for
,
,
,, ,
,
,
+
+
+
+
+
=
−
−+ −
≥
<
1
1
1
1
λ 1
268 BARBERIS, HUANG, SANTOS