Myopic Loss Aversion and the Equity Premium Puzzle
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What they found
Why do stocks earn so much more than bonds if people are only moderately risk averse? Benartzi and Thaler propose that investors are loss averse and evaluate their portfolios too frequently. Checking a stock portfolio every day or month means seeing losses nearly half the time, and each loss stings twice as much as a gain pleases, so stocks feel far riskier than their long-run record justifies. Calibrating to prospect theory, they show the historical equity premium is consistent with investors who evaluate their portfolios about once a year.
What you can use
- The more often you look at your P&L, the more painful and risky a good strategy feels, because short-horizon returns are mostly noise.
- Loss aversion plus frequent checking leads people to abandon sound positions and strategies too early.
- Choosing how often to evaluate performance is itself a risk-management decision.
Caveats
A calibration exercise, not a direct test; other explanations of the equity premium exist. Assumes prospect-theory parameters from lab studies.
Tags: behavioral, loss-aversion, evaluation-frequency, equity-premium
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.