Abstract
The relationship between risk and return is not symmetric under different circumstances. As the prospect theory describes, the value function which passes through the reference point is steeper for losses than gains (asymmetric risk appetite). But such an asymmetrical risk aversion could be traced in different periods of investment and market boom and bust cycles behind the reference point. Moreover, investors’ asymmetric behavior is different regarding various risks, such as market risk, illiquidity risk, and credit risk. This paper examines the asymmetric investors' reaction to various risks in Tehran Stock Exchange (TSE) both in recession and growth from 2011 through 2016. Evidence reveals that although all three kinds of risks are relevant, especially illiquidity risk, risk factors’ explanation power in the bullish market is less than the bearish one. This indicates that investors tend to show an asymmetric reaction to risk in up and downswing markets. The asymmetric behavior is also predominant due to investors’ weak attention to the market risk in a growing market in opposition to a recessive market condition that turns out to be an important risk consideration. The results of this study can help investors to consider asymmetrical behavior effect when they are making their minds on investment decisions.
Highlights
Risk, return, and their relationship are key factors in the process of investment decision-making
This differs from expected utility theory, in which a rational agent is indifferent to the reference point because the value function passes through the reference point in the prospect theory, and we consider investors’ reactions to risks asymmetrically by the prospect theory
Based on expected utility theory, individuals are risk-averse in the presence of risky outcomes, this means that the individual would refuse a fair game
Summary
Return, and their relationship are key factors in the process of investment decision-making. Investors usually tend to avoid risk, and simultaneously move to maximize return. Theories indicate that returns should change along the time and these changes increase the investment risk. Various studies have presented evidence on this point (Sadat, Abbasi & Ghalibaf Asl, 2020). In other words, are risk-averse in an efficient market and would invest in risky securities only if they gain a higher amount of return than usual. Mathematical interpretation is that a security price function is reversely related to risk and directly to return
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