On the Optimality of Behavioral Portfolio Construction Methods

Murat Mazibas (Lead / Corresponding author), Richard D. F. Harris

Research output: Contribution to conferencePaperpeer-review

Abstract

In this article, we explore whether optimization methods proposed for the construction of CPT portfolios increase the chance of a representative investor to survive on his portfolio decisions and whether constructed behavioral portfolios are optimal for a rational investor. We evaluate the estimation methods that have been proposed in the literature for the estimation of CPT models and test their out-of-sample performance. We also establish the location of each estimation method on the efficient frontier of a rational and a behavioral investor. We report four main findings. First, CPT strategies generally exhibit both lower return and higher risk than the mean-variance investor. Second, while CPT strategies underperform the mean-variance strategy from a rational risk-adjusted return perspective, the CPT investors generally ‘believe’ that they outperform mean-variance investors due to their subjective evaluations. Third, the CPT strategies are not ‘optimal’ from a fully rational investor’s perspective with the exception of the HFR strategy. Similarly, the CPT strategies are not ‘optimal’ from a fully behavioral investor’s perspective with the exception of the QE strategy.
Original languageEnglish
Publication statusPublished - Aug 2020
Event22nd International Conference on Economics, Management, Finance and the Social Sciences: organized by World Academy of Science, Engineering and Technology - London, London, United Kingdom
Duration: 20 Aug 202021 Aug 2020
https://waset.org/

Conference

Conference22nd International Conference on Economics, Management, Finance and the Social Sciences
Abbreviated titleICEMFSS 2020
Country/TerritoryUnited Kingdom
CityLondon
Period20/08/2021/08/20
Internet address

Keywords

  • Portfolio optimization
  • behavioral finance
  • cumulative prospect theory
  • portfolio construction
  • behavioral efficient frontier
  • mean-variance efficient frontier
  • mean-variance optimization

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