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Cumulative prospect theory and mean variance analysis. A rigorous comparison


Hens, Thorsten; Mayer, Janos (2012). Cumulative prospect theory and mean variance analysis. A rigorous comparison. NCCR FINRISK Working Paper 792, University of Zurich.

Abstract

We compare asset allocations derived for cumulative prospect theory(CPT) based on two different methods: Maximizing CPT along the mean–variance efficient frontier and maximizing it without that restriction. We find that with normally distributed returns the difference is negligible. However, using standard asset allocation data of pension funds the difference is considerable. Moreover, with derivatives like call options the restriction to the mean-variance efficient frontier results in a sizable loss of e.g. expected return and expected utility.

Abstract

We compare asset allocations derived for cumulative prospect theory(CPT) based on two different methods: Maximizing CPT along the mean–variance efficient frontier and maximizing it without that restriction. We find that with normally distributed returns the difference is negligible. However, using standard asset allocation data of pension funds the difference is considerable. Moreover, with derivatives like call options the restriction to the mean-variance efficient frontier results in a sizable loss of e.g. expected return and expected utility.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
JEL Classification:C61, D81, G02, G11
Language:English
Date:July 2012
Deposited On:15 Aug 2012 07:06
Last Modified:10 Nov 2017 06:12
Series Name:NCCR FINRISK Working Paper
Number of Pages:51
ISSN:1380-6645
Official URL:http://www.nccr-finrisk.uzh.ch/media/pdf/wp/WP792_A1.pdf

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