Loss aversion, survival and asset prices

This paper studies the wealth and pricing implications of loss aversion in the presence of arbitrageurs with Epstein-Zin preferences. Our analysis shows that if loss aversion is the only difference in investors’ preferences, then for empirically relevant parameter values, loss-averse investors will be driven out of the market and do not affect long run prices. The selection process is slow in terms of wealth shares; but it is effective in terms of price impacts, because of endogenous withdrawal by loss-averse investors from the stock market. Overall, the market selection mechanism is efficient.