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Humans, Econs and Portfolio Choice

Author

Listed:
  • Michael J. Best

    (Department of Combinatorics and Optimization, Faculty of Mathematics University of Waterloo, Waterloo, Ontario, Canada)

  • Robert R. Grauer

    (Beedie School of Business Simon Fraser University, 8888 University Drive Burnaby, British Columbia, Canada V5A 1S6, Canada)

Abstract

We compare the portfolio choices of Humans — prospect theory investors — to the portfolio choices of Econs — power utility and mean-variance (MV) investors. In a numerical example, prospect theory portfolios are decidedly unreasonable. In an in-sample asset allocation setting, the prospect theory results are consistent with myopic loss aversion. However, the portfolios are extremely unstable. The power utility and MV results are consistent with traditional finance theory, where the portfolios are stable across decision horizons. In an out-of-sample asset allocation setting, the power utility and portfolios outperform the prospect theory portfolios. Nonetheless the prospect theory portfolios with loss aversion coefficients of 2.25 and 2 perform well.

Suggested Citation

  • Michael J. Best & Robert R. Grauer, 2017. "Humans, Econs and Portfolio Choice," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 7(02), pages 1-30, June.
    • Handle: RePEc:wsi:qjfxxx:v:07:y:2017:i:02:n:s201013921750001x
    DOI: 10.1142/S201013921750001X
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