Behavioral portfolio theory
Encyclopedia
Behavioral portfolio theory (BPT) was published by Shefrin and Statman. This theory essentially tries to provide a contrast to the fact that the ultimate motivation for investors is the maximization of the value of their portfolios. It suggests that investors have varied aims and create an investment portfolio that meets a broad range of goals.
It does not follow the same principles as the Capital Asset Pricing Model
, Modern Portfolio Theory
and the Arbitrage Pricing Theory
. A behavioral portfolio bears a strong resemblance to a pyramid with distinct layers. Each layer has well defined goals. The base layer is devised in a way that it is meant to prevent financial disaster, whereas, the upper layer is devised to attempt to maximize returns, an attempt to provide a shot at becoming rich.
BPT is a descriptive theory based on the SP/A theory of Lola Lopez (1987), and closely related to Roy's safety-first criterion
. The theory is described as a single account version: BPT-SA, which is very closely related to the SP/A theory. The true genius of the authors resides in the multiple account version: BPT-MA.
In this multiple account version, investors can have fragmented portfolios, just as we observe among investors. They even propose in their initial article a Cobb–Douglas utility function that shows how money is allocated in the two mental accounts.
It does not follow the same principles as the Capital Asset Pricing Model
Capital asset pricing model
In finance, the capital asset pricing model is used to determine a theoretically appropriate required rate of return of an asset, if that asset is to be added to an already well-diversified portfolio, given that asset's non-diversifiable risk...
, Modern Portfolio Theory
Modern portfolio theory
Modern portfolio theory is a theory of investment which attempts to maximize portfolio expected return for a given amount of portfolio risk, or equivalently minimize risk for a given level of expected return, by carefully choosing the proportions of various assets...
and the Arbitrage Pricing Theory
Arbitrage pricing theory
In finance, arbitrage pricing theory is a general theory of asset pricing that holds that the expected return of a financial asset can be modeled as a linear function of various macro-economic factors or theoretical market indices, where sensitivity to changes in each factor is represented by a...
. A behavioral portfolio bears a strong resemblance to a pyramid with distinct layers. Each layer has well defined goals. The base layer is devised in a way that it is meant to prevent financial disaster, whereas, the upper layer is devised to attempt to maximize returns, an attempt to provide a shot at becoming rich.
BPT is a descriptive theory based on the SP/A theory of Lola Lopez (1987), and closely related to Roy's safety-first criterion
Roy's safety-first criterion
Roy's safety-first criterion is a risk management technique that allows an investor to select one portfolio rather than another based on the criterion that the probability of the portfolio's return falling below a minimum desired threshold is minimized....
. The theory is described as a single account version: BPT-SA, which is very closely related to the SP/A theory. The true genius of the authors resides in the multiple account version: BPT-MA.
In this multiple account version, investors can have fragmented portfolios, just as we observe among investors. They even propose in their initial article a Cobb–Douglas utility function that shows how money is allocated in the two mental accounts.