Behavioral Portfolio Theory

Abstract

We develop a positive behavioral portfolio theory and explore its implications for portfolio construction and security design. Portfolios within the behavioral framework resemble layered pyramids. Layers are associated with distinct goals and covariances between layers are overlooked. We explore a simple two-layer portfolio. The downside protection layer is designed to prevent financial disaster. The upside potential layer is designed for a shot at becoming rich. Behavioral portfolio theory has predictions that are distinct from those of meanvariance portfolio theory. In particular, behavioral portfolio theory is consistent with the reluctance to have short and margined positions, an inverse relation between the bond/stock ratio and portfolio riskiness, the existence of the home bias, the use of labels such as “growth ” and “income, ” the preference for securities with floors on returns, and the purchase of lottery tickets. 2 Behavioral Portfolio Theory We develop behavioral portfolio theory as a descriptive theory, an alternative to

Cite this work

No public copy is stored for this record, so only the metadata is cited.

Stored only when both papers are in the corpus — 45 citations exist upstream.