Goal-Based Investing with Cumulative Prospect Theory and Satisficing Behavior

Enrico De Giorgi ()

University of St. Gallen Department of Economics working paper series 2009 from Department of Economics, University of St. Gallen

Abstract: This paper presents a time-continuous goal-based portfolio selection model with cumulative prospect theory preferences and satisficing behavior, where investors optimally split their wealth among several investment goals at different horizons. The paper extends the model of Berkelaar, Kouwenberg and Post (2004) to account for multiple-goals. We show that when the discounted values of all target wealths is not too high relative to the initial wealth (i.e., goals are not too ambitious), investors mainly invest to reach short-term investment goals and adopt safe investment strategies for this purpose. However, when goals are very ambitious, they put a high proportion of their wealth in long-term goals and adopt aggressive investment strategies with high leverage to reach short-term goals and the overall investment strategy also displays high leverage. High incentives to reach ambitious shortterm goals (high target returns) and the consequent excessive leverage have been identified as causes for the global financial crisis erupted in 2008.

Keywords: behavioral finance; portfolio selection; mental accounting; narrow framing; cumulative prospect theory; satisficing; loss aversion; goal-based approach (search for similar items in EconPapers)
JEL-codes: D10 G11 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2009-08
New Economics Papers: this item is included in nep-cbe and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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