Why are investors loss averters during bull markets and gain seekers during bear markets?

How does market trend sentiment affect investors’ asymmetric loss-gain tradeoffs? Several empirical tests indicate that investors are far more loss adverse during bull markets than during bear markets (see Hwang and Satchell, 2010; Hofschire et al, 2013). In this paper we provide a sound theoretical foundation for this empirical evidence. First, we discuss how to identify the subjectively perceived market trend sentiment. Then, we propose a reference dependent definition of loss aversion and gain appetite, that generalizes the seminal Kahneman and Tversky (1979, p. 279) and Kahneman and Tversky (1992, p. 303) loss aversion definition. We show that under mild technical assumptions on utility functions, asymmetrical loss-gain evaluations are normatively influenced by the subjective perception of market trend. Specifically, investors are normatively lead to loss aversion during perceived bullish markets and to risk appetite during perceived bearish markets. This market trend dependence holds for the most popular utility functions used in the expected utility and prospect theory.