An aspirational perspective on the negative risk-return relationship

The existence of a negative risk -return relationship challenges the conventional wisdom of finance, which typically assumes a positive correlation between risk and return. Referencedependent preferences, motivated by prospect theory, offer a possible explanation for this negative risk -return relation. However, as we demonstrate in this paper prospect theory does not provide a general explanation for this puzzle. We show that the expected utility theory with an aspiration level can effectively account for this phenomenon.