Rational distorted beliefs investor; which risk matters?

Mohammed Bouaddi and Khouzeima Moutanabbir

Finance Research Letters, 2023, vol. 51, issue C

Abstract: This paper considers a portfolio strategy in which the investor applies beliefs distortion to allocate different weights to different kinds of risk in the context of Markovitz portfolio. We assume that the investor decomposes the aggregate risk into three different components:fundamental observed factors’ risk, fundamental non-observed factors’ risk and idiosyncratic risk. Our distorted beliefs’ portfolio outperforms the traditional mean–variance and the naive portfolios. We also find that the rational investor prefers to bear more observed fundamental risk and minimize other risks.

Keywords: Mean–variance portfolio; Distorted beliefs; Idiosyncratic risks; Fundamental risks (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:51:y:2023:i:c:s1544612322006080

DOI: 10.1016/j.frl.2022.103431

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