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Can utility optimization explain the demand for structured investment products?

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  • Thorsten Hens
  • Marc Oliver Rieger

Abstract

In this paper, we first show that for classical rational investors with correct beliefs and constant absolute or constant relative risk aversion, the utility gains from structured products over and above a portfolio consisting of the risk-free asset and the market portfolio are typically much smaller than their fees. This result holds irrespectively of whether the investors can continuously trade the risk-free asset and the market portfolio at no costs or whether they can just buy the assets and hold them to maturity of the structured product. However, when considering behavioural utility functions, such as prospect theory, or investors with incorrect beliefs (arising from probability weighting or probability misestimation), the utility gain can be sizable.

Suggested Citation

  • Thorsten Hens & Marc Oliver Rieger, 2014. "Can utility optimization explain the demand for structured investment products?," Quantitative Finance, Taylor & Francis Journals, vol. 14(4), pages 673-681, April.
    • Handle: RePEc:taf:quantf:v:14:y:2014:i:4:p:673-681
    DOI: 10.1080/14697688.2013.823512
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