CHAPTER 23
Behavioral Portfolio Theory and Investment Management
INTRODUCTION
The goal of this chapter is to provide a survey of the most important development in behavioral portfolio theory. The chapter has the following organization. The first section examines prospect theory (PT) and compares it to expected utility theory (EUT). It extends the concept of loss aversion to myopic loss aversion. The second section introduces safety-first portfolio theory as a precursor to the SP/A theory, which is discussed in third section. The evaluation of the risky outcomes is based on the need for security (fear) and potential (hope) as well as a given aspiration level. This section concludes by comparing SP/A theory and PT.
Next, behavioral portfolio theory (BPT) is presented as a combination of some main ideas from SP/A theory and PT. Two major specifications of BPT are described and compared to conventional portfolio theory. One considers a single mental account and the other considers multiple mental accounts.
The last section introduces the behavioral asset pricing model (BAPM). The consumption preferences are classified as utilitarian and value-expressive preferences. BAPM is compared to CAPM and the three-factor model. The chapter finishes with two discussions on the impact of value ...
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