Behavioral dynamic portfolio selection with S-shaped utility and epsilon-contaminations

Andrea Cinfrignini, Davide Petturiti and Barbara Vantaggi

European Journal of Operational Research, 2025, vol. 325, issue 3, 500-515

Abstract: Inspired by the classical cumulative prospect theory (CPT), we propose a CPT-like functional characterized by the modeling of uncertainty on gains and losses through two epsilon-contaminations of a reference probability measure. Such functional is used to perform a dynamic portfolio selection in a finite horizon binomial market model, reducing it to an iterative search problem over the set of optimal solutions of a family of pairs of non-linear optimization problems on the final wealth. Despite the computational hardness of the resulting pairs of problems, epsilon-contaminations allow to represent each solution in terms of the partition generated by the stock price random variable at maturity, obtaining a sensible reduction of variables and constraints. In turn, the optimization task can be reduced to the maximization of a real-valued function of one real variable, revealing the possible ill-posedness of the problem. The resulting model is discussed by means of some paradigmatic examples on market data and a sensitivity analysis.

Keywords: Portfolio optimization; Uncertainty modeling; Behavioral investor; S-shaped utility function; Epsilon-contamination (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:325:y:2025:i:3:p:500-515

DOI: 10.1016/j.ejor.2025.03.029

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