1. ¹has been Professor of Finance at the Warwick Business School since 2004. Prior to that he was a professor at the Cass Business School, London. He has wide research interests, but the current focus is on behavioural finance, credit risk and derivatives. He has been a consultant to a variety of exchanges and other organisations in the City of London.
2. ²is a reader in finance at the Cass Business School. He received his PhD from Cambridge University. His research interests include behavioural finance, asset pricing and real estate finance. He worked as a fund manager and as an auditor, and has been a consultant to various financial institutions.
3. ³is a professor of finance at Warwick Business School, and Director of the Financial Econometrics Research Centre and Warwick Finance Research Institute. He has been an advisor to the Bank of England for the last five years and has held visiting positions at Princeton, Nuffield College Oxford and Paris 1 amongst other places in the USA, Australia and Italy.

Correspondence: Soosung Hwang, Faculty of Finance, Cass Business School, 106 Bunhill Row, London, EC1Y 8TZ, UK, Tel +44 (0)20 7040 0109; Fax +44 (0)20 7040 8881; e-mail: s.hwang@city.ac.uk

Revised 19 April 2006.

Abstract

This paper explains how prospect theory can be applied to fund performance, extending work by Darsinos and Satchell (Generalising Universal Performance Measures', Risk, 17(6), 80–84, 2004). It then uses data on closed-end funds in the UK to show that the resulting loss-averse performance measure (LAP) gives different rankings from those of conventional measures (such as the Sharpe ratio, Jensen's alpha, the Sortino ratio and the Higher Moment measure). Loss-averse performance has the desirable property of being negatively correlated with the volatility and kurtosis of tracking errors. It is not more closely related to discounts on funds than are conventional measures of performance, however, so no evidence is found that loss-aversion in the short-term is a factor in attracting investors to particular funds.