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Institutional Investors, Past Performance, and Dynamic Loss Aversion

Published online by Cambridge University Press:  01 February 2009

Paul G. J. O’Connell  and
Melvyn Teo
Paul G. J. O’Connell
Affiliation:
FDO Partners LLC, 5 Revere St., Cambridge, MA 02138. paul.oconnell@fdopartners.com
Melvyn Teo
Affiliation:
Singapore Management University, 50 Stamford Rd., Singapore 178899, Singapore. melvynteo@smu.edu.sg
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Abstract

Using a proprietary database of currency trades, this paper explores the effects of trading gains and losses on risk-taking among large institutional investors. We find that institutional investors, unlike individuals, are not prone to the disposition effect. Instead, institutions aggressively reduce risk following losses and mildly increase risk following gains. This asymmetry is more pronounced later in the calendar year and among older and more experienced funds. We show that such performance dependence is consistent with dynamic loss aversion (Barberis, Huang, and Santos (2001)) and overconfidence. In addition, prior institutional gains and losses have palpable implications for future prices.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 44 , Issue 1 , February 2009 , pp. 155 - 188
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2009

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