Portfolios of value and momentum: disappointment aversion and non-normalities

Professional money managers often combine value and momentum to benefit from diversification gains resulting from their negative return correlation. We go beyond the mean-variance and constant relative risk aversion environments to investigate this fundamental issue by assuming that investors exhibit disappointment aversion, and empirically account for the non-normalities and non-linear dependencies of the returns associated with these strategies. We perform an exploration exercise on the interplay of these two general sets of assumptions. In accordance with the literature, we find that disappointment preferences lead to optimal portfolio choices that are not attainable under the traditional constant relative risk aversion case. The findings reveal that higher disappointment aversion utility levels can be reached when non-normalities are introduced in the optimization process. The intensity of this phenomenon rises as disappointment aversion increases. However, taking advantage of these non-linearities and non-normalities requires higher portfolio turnovers. Therefore, when introducing transaction costs in the analysis, we find significant improvement in certainty equivalent returns only for investors having high disappointment aversion levels and facing low transaction costs.