Evidence on Dynamic Loss Aversion from Currency Portfolios

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, the authors demonstrate that this dynamic loss aversion spans multiple frames of reference. Losses are not compartmentalized, but rather a loss in one currency may impact trading in another. The authors also show that while the impact of a loss on subsequent trading decisions does linger, the effect declines sharply after a losing position is closed.