The Cause Of Myopic Loss Aversion

From 1927 through 2015, there has been a very large difference between the returns to the S&P 500 and the returns to risk-free Treasury bills—about 8.5% on an annual average basis and about 6.7% on an annualized basis. This large spread is frequently referred to as the equity premium puzzle, because unless investors possess implausibly high levels of risk aversion, the equity premium’s historical average is too high to be justified by standard economic models.

Shlomo Benartzi and Richard Thaler, authors of the study “Myopic Loss Aversion and the Equity Premium Puzzle,” which was published in the February 1995 edition of The Quarterly Journal of Economics, proposed that the puzzle’s answer lies in a behavior known as myopic loss aversion (MLA). MLA describes the tendency of investors who are loss-averse (the pleasure felt after observing a gain is inferior to the pain experienced after a loss of an equivalent amount) to evaluate their portfolios too frequently, thus causing them to take a short-term view of investing (losses are experienced more frequently at narrow time scales).

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