Journal article
Static portfolio choice under Cumulative Prospect Theory
Mathematics and financial economics, Vol.2(4), pp.277-306
03/01/2010
DOI: 10.1007/s11579-009-0021-2
Abstract
We derive the optimal portfolio choice for an investor who behaves according to Cumulative Prospect Theory (CPT). 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 CPT 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.
Details
- Title: Subtitle
- Static portfolio choice under Cumulative Prospect Theory
- Creators
- Carole Bernard - University of WaterlooMario Ghossoub - University of Waterloo
- Resource Type
- Journal article
- Publication Details
- Mathematics and financial economics, Vol.2(4), pp.277-306
- DOI
- 10.1007/s11579-009-0021-2
- ISSN
- 1862-9679
- eISSN
- 1862-9660
- Publisher
- Springer Nature
- Number of pages
- 30
- Grant note
- Natural Sciences and Engineering Research Council of Canada; Natural Sciences and Engineering Research Council of Canada (NSERC); CGIAR
- Language
- English
- Date published
- 03/01/2010
- Academic Unit
- Statistics and Actuarial Science
- Record Identifier
- 9985179849202771
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