Humans, Econs and Portfolio Choice

Michael J. Best () and Robert R. Grauer
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Michael J. Best: Department of Combinatorics and Optimization, Faculty of Mathematics University of Waterloo, Waterloo, Ontario, Canada
Robert R. Grauer: Beedie School of Business Simon Fraser University, 8888 University Drive Burnaby, British Columbia, Canada V5A 1S6, Canada

Quarterly Journal of Finance (QJF), 2017, vol. 07, issue 02, 1-30

Abstract: We compare the portfolio choices of Humans — prospect theory investors — to the portfolio choices of Econs — power utility and mean-variance (MV) investors. In a numerical example, prospect theory portfolios are decidedly unreasonable. In an in-sample asset allocation setting, the prospect theory results are consistent with myopic loss aversion. However, the portfolios are extremely unstable. The power utility and MV results are consistent with traditional finance theory, where the portfolios are stable across decision horizons. In an out-of-sample asset allocation setting, the power utility and portfolios outperform the prospect theory portfolios. Nonetheless the prospect theory portfolios with loss aversion coefficients of 2.25 and 2 perform well.

Keywords: Portfolio choice; prospect theory; kinked linear utility; power utility; mean variance (search for similar items in EconPapers)
Date: 2017
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DOI: 10.1142/S201013921750001X

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