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Goal-Based Investing with Cumulative Prospect Theory and Satisficing Behavior

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  • Enrico G. De Giorgi

Abstract

This paper presents a time-continuous goal-based portfolio selection model with cumulative prospect theory preferences and satisficing behavior, where investors optimally split their wealth among several investment goals at different horizons. The paper extends the model of Berkelaar, Kouwenberg and Post (2004) to account for multiple-goals. We show that when the discounted values of all target wealths is not too high relative to the initial wealth (i.e., goals are not too ambitious), investors mainly invest to reach short-term investment goals and adopt safe investment strategies for this purpose. However, when goals are very ambitious, they put a high proportion of their wealth in long-term goals and adopt aggressive investment strategies with high leverage to reach short-term goals and the overall investment strategy also displays high leverage. High incentives to reach ambitious shortterm goals (high target returns) and the consequent excessive leverage have been identified as causes for the global financial crisis erupted in 2008.

Suggested Citation

  • Enrico G. De Giorgi, 2009. "Goal-Based Investing with Cumulative Prospect Theory and Satisficing Behavior," University of St. Gallen Department of Economics working paper series 2009 2009-22, Department of Economics, University of St. Gallen.
    • Handle: RePEc:usg:dp2009:2009-22
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    File URL: http://ux-tauri.unisg.ch/RePEc/usg/dp2009/DP-0922-Gi.pdf
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    References listed on IDEAS

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    Cited by:

    1. Omid Momen & Akbar Esfahanipour & Abbas Seifi, 2020. "A robust behavioral portfolio selection: model with investor attitudes and biases," Operational Research, Springer, vol. 20(1), pages 427-446, March.

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    More about this item

    Keywords

    behavioral finance; portfolio selection; mental accounting; narrow framing; cumulative prospect theory; satisficing; loss aversion; goal-based approach;
    All these keywords.

    JEL classification:

    • D10 - Microeconomics - - Household Behavior - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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