Article | Journal of Portfolio Management | fall 2011

How Institutional Investors Frame Their Losses: Evidence on Dynamic Loss Aversion from Currency Portfolios

by Kenneth A. Froot, J. Arabadjis, S. Cates and S. Lawrence

Abstract

Currency investors exhibit a tendency to cut risk by pairing both longs and shorts following losses and a weaker tendency to add risk following gains. By differentiating between position level, portfolio level, and aggregate cross-portfolio losses in currency investments, we demonstrate that this dynamic loss aversion spans multiple frames of reference. Losses are not compartmentalized; rather a loss in one currency may impact trading in another. We also show that while the impact of a loss on subsequent trading decisions does linger, the affect declines sharply after a losing position is closed.

Keywords: Loss aversion; Decision Choices and Conditions; Currency; Investment; Risk Management; Behavioral Finance;

Citation:

Froot, Kenneth A., J. Arabadjis, S. Cates, and S. Lawrence. "How Institutional Investors Frame Their Losses: Evidence on Dynamic Loss Aversion from Currency Portfolios." Journal of Portfolio Management 38, no. 1 (fall 2011): 60–68.