Bernard, Carole and Ghossoub, Mario (2009): Static Portfolio Choice under Cumulative Prospect Theory.
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We derive the optimal portfolio choice for an investor who behaves according to Cumulative Prospect Theory. The study is done in a one-period economy with one risk-free asset and one risky asset, and the reference point corresponds to the terminal wealth arising when the entire initial wealth is invested into the risk-free asset. When it exists, the optimal holding is a function of a generalized Omega measure of the distribution of the excess return on the risky asset over the risk-free rate. It conceptually resembles Merton’s optimal holding for a CRRA expected-utility maximizer. We derive some properties of the optimal holding and illustrate our results using a simple example where the excess return has a skew-normal distribution. In particular, we show how a Cumulative Prospect Theory investor is highly sensitive to the skewness of the excess return on the risky asset. In the model we adopt, with a piecewise-power value function with diﬀerent shape parameters, loss aversion might be violated for reasons that are now well-understood in the literature. Nevertheless, we argue that this violation is acceptable.
|Item Type:||MPRA Paper|
|Original Title:||Static Portfolio Choice under Cumulative Prospect Theory|
|Keywords:||Cumulative Prospect Theory, Portfolio Choice, Behavioral Finance, Omega Measure.|
|Subjects:||D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty
G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions
|Depositing User:||Mario Ghossoub|
|Date Deposited:||29. Jul 2009 14:38|
|Last Modified:||12. Feb 2013 03:39|
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Static Portfolio Choice under Cumulative Prospect Theory. (deposited 01. Jun 2009 07:02)
Static Portfolio Choice under Cumulative Prospect Theory. (deposited 13. Jul 2009 23:43)
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- Static Portfolio Choice under Cumulative Prospect Theory. (deposited 13. Jul 2009 23:43)