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Suboptimal investment behavior and welfare costs: A simulation based approach

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  • Castañeda, Pablo
  • Reus, Lorenzo

Abstract

We propose a representation of suboptimal investment behavior based on the stochastic discount factor (SDF) paradigm. Suboptimal investment behavior is rationalized as being the investor’s optimal decision under a wrong SDF, while wealth trajectories and budget constraints are based on the true SDF. We develop a novel Monte Carlo simulation approach to compute the welfare costs for this suboptimal behavior.

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  • Castañeda, Pablo & Reus, Lorenzo, 2019. "Suboptimal investment behavior and welfare costs: A simulation based approach," Finance Research Letters, Elsevier, vol. 30(C), pages 170-180.
    • Handle: RePEc:eee:finlet:v:30:y:2019:i:c:p:170-180
    DOI: 10.1016/j.frl.2018.09.009
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    More about this item

    Keywords

    Asset allocation; Martingale method; Portfolio selection; Suboptimal investment; Monte Carlo simulation; Welfare loss;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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