A Dynamic Variation of Risk Aversion Approach : A Study of Momentum and Reversal Premiums

This paper integrates dynamic loss aversion and individual narrow framing in the investor utility function. The paper investigates investor behavior following the public announcement of earnings. To do this, the author optimizes the objective function of investor preference and analyzes to what extent the preference function generates a differential of value premium between stocks after the announcement of the firms' profits. Several simulations are used according to the different values considered for the preference parameters. The results show that in the short run, negative information infiltrates financial markets slowly as the adjustment coefficient of investor preference is below one. An important momentum premium is then noted. In the long run, reversal trends in returns generated by the preference framework confirm that investors feel very upset after the release of successive earnings of negative sign. In fact, losses that come after other losses are very painful for them as they have a dynamic loss aversion function