Abstract
We examine the portfolio choice of an investor with generalized disappointment aversion preferences who faces returns described by a normal-exponential model. We derive a three-fund separation strategy: the investor allocates wealth to a risk-free asset, a standard mean-variance efficient fund, and an additional fund reflecting return asymmetries. The optimal portfolio is characterized by the investor's endogenous effective risk aversion and implicit asymmetry aversion. We find that disappointment aversion is associated with much larger asymmetry aversion than are standard preferences. Our model explains patterns in popular portfolio advice and provides a reason for shifting from bonds to stocks as the investment horizon increases.