an economic theory of self control the concept of self control is incorporated in a theory of individual intertemporal choice by modeling the individual as an organization the individual at a point in time is assumed to be both a farsighted planner and a myopic doer the resulting conflict is seen to be fundamentally similar to the agency conflict between the owners and managers of a firm both individuals and firms use the same techniques to mitigate the problems which the conflicts create this paper stresses the implications of this agency model and discusses as applications the effect of pensions on saving saving and the timing of income flows and individual discount rates

preferred risk habitat of individual investors abstract the preferred risk habitat hypothesis introduced here is that individual investors select stocks whose volatilities are commensurate with their risk aversion the data 1995 2000 holdings of over 20 000 clients at a large german broker are consistent with the predictions of the hypothesis the returns of stocks within each portfolio have remarkably similar volatilities when stocks are sold they are replaced by stocks of similar volatilities and the more risk averse customers indeed hold less volatile stocks greater volatility specialization is associated with lower sharpe ratios primarily because more specialized investors hold fewer stocks and thereby expose themselves to more unsystematic risk

effectiveness of developed and emerging market fx options in active currency risk management abstract we analyze the effectiveness of developed and emerging market foreign exchange options in international portfolios as a complement to forwards for actively managing portfolio currency risks under the behavioral framework although prior research finds forwards dominate options using the mean variance framework measures using other objectives may prove more insightful we find that foreign exchange options can be useful behavioral complements to forwards for currency risk management from a perspective of regret risk mean skewness and cross asset lower tail dependence we also draw parallels and contrasts between developed and emerging market foreign exchange options from a behavioral perspective

a behavioral framework for time diversification the box of factors that we call risk is both too large and too small the box is large enough to include many sometimes conflicting measures of risk variance and semivariance probabilities of losses and their amounts but the box is too small to include factors that affect choices but fall outside the boundaries of risk frames and cognitive errors self control and regret we explore the role of these factors in time diversification the belief that time diversification reduces risk underlies the current drive to invest social security funds in stocks but is such investment prudent we discuss the role of advisors in providing prudent advice changes in the standards of prudence over time the use of time diversification in guiding investors to prudent portfolios and its use in the current debate on social security

ex day behavior with dividend preference and limitations to short term arbitrage the case of swedish lottery bonds abstract swedish lottery bonds offer a unique opportunity to study ex day effects in an environment where cash distributions are tax advantaged relative to capital gains thus in the lottery bond market we observe a reversal of the preference for capital gains that researchers have cited as an explanation for the ex day behavior of u s equities further in this market there are barriers to short term arbitrage when prices do reflect the tax preferences of individual investors we find the bonds are priced around the ex day to reflect differential tax rates on income and capital gains consistent with the prevailing tax regimes the bonds consistently experience negative returns over the coupon payment period and in fact often sell at negative yields prior to the cash distribution as one would expect given tax motivated trading between high tax investors who buy prior to the distribution and low tax investors who buy after the distribution

investor sentiment and the financial crisis a sentiment based portfolio theory perspective the article proposes a portfolio model subjected to a constraint that captures the investor s goal with maximum estimation of expected return that is affected by investor sentiment and we give a solution of the portfolio model by exploring the geometric features furthermore we discuss the relationship between investor sentiment and the financial crisis by analysing the optimal allocation the results show that when investor sentiment is low enough the investor should reject the investment this condition leads the depression financial market to prevail then the financial crisis erupts when investor sentiment is modest the financial crisis is difficult to erupt unless the decline of investor sentiment is quick and deep but there is a special status that the financial crisis is caused by other factors rather than by investor sentiment and only improving investor sentiment cannot move away from the financial crisis

international portfolio choice and political instability risk a multi objective approach abstract the benefits derived from international portfolio diversification into foreign nations including the less developed countries are well documented yet this practice is discouraged due to market imperfections such as political instability in practice nations may be differentiated further by many aspects such as border controls or political and social trends which constrain private transactions and financial decisions this paper attempts to examine 1 whether the home asset bias in a portfolio holding is associated with higher political instability risk and 2 to what extent international diversification among stocks in the presence of such risk outperforms domestic stock portfolios using alternative instability risk proxies in the context of a discrete time version of mean variance framework we corroborate the impact of this type of risk on international portfolio investment decisions

cautious risk takers investor preferences and demand for active management actively managed mutual funds have distinct return distributions from their passive benchmarks and our theoretical analysis using tail sensitive risk preferences suggests that active value and growth funds may serve to reduce downside risk and capture upside potential respectively furthermore tail sensitivity measures estimated from the empirical pricing kernel have significant explanatory power for active fund flows even after controlling for business cycles and market wide sentiment finally active funds unlike their passive counterparts have exposures to option strategies hedging downside risk or capturing upside potential

behavioral biases of mutual fund investors we examine the effect of behavioral biases on the mutual fund choices of a large sample of us discount brokerage investors using new measures of attention to news tax awareness and fund level familiarity bias in addition to behavioral and demographic characteristics of earlier studies behaviorally biased investors typically make poor decisions about fund style and expenses trading frequency and timing resulting in poor performance furthermore trend chasing appears related to behavioral biases rather than to rationally inferring managerial skill from past performance factor analysis suggests that biased investors often conform to stereotypes that can be characterized as gambler smart overconfident narrow framer and mature

portfolio selection with mental accounts and delegation das et al 2010 develop an elegant framework where an investor selects portfolios within mental accounts but ends up holding an aggregate portfolio on the mean variance frontier this investor directly allocates the wealth in each account among available assets in practice however investors often delegate the task of allocating wealth among assets to portfolio managers who seek to beat certain benchmarks accordingly we extend their framework to the case where the investor allocates the wealth in each account among portfolio managers our contribution is threefold first we provide an analytical characterization of the existence and composition of the optimal portfolios within accounts and the aggregate portfolio second we present conditions under which such portfolios are not on the mean variance frontier and conditions under which they are third we show that the aforementioned analytical characterization is also applicable within the framework of das et al and thus improves upon their numerical approach

ownership effects among native american banks 2001 2016 abstractminority depository institutions mdis including native american banks natbs play an integral role in providing financial services to the under served natbs are split between those th

capital accumulation and deposit pricing in mutual financial institutions this paper presents a multiperiod model of a deposit type mutual financial institution and analyzes the manager s capital accumulation and deposit pricing decisions under uncertainty the model is meant to describe a mutual savings and loan assoeiation sla or a credit union in which there are no stockholders

on the policy ineffectiveness proposition and a keynesian alternative a rejoinder i the basis of rush and waldo s rw results is the introduction of a war dummy variable in the dg equation this is however difficult to justify in the context of a rational expectations model under incomplete learning wars by their very nature are unique events and it is not clear how the public are supposed to learn the quantitative effects that the ending of three totally different wars may have had upon the growth of real government expenditure the fact that in i946 the public knew that world war ii was over does not mean that they could also estimate its precise quantitative effect on government expenditure rw estimate their dg equation using data for the whole of the period i943 73 and i943 85 thus implicitly assuming that all these data were available to the public in i946 for the computation of the coefficient of the war dummy in the dg equation but in i946 the public could not possibly have known about the timing and the intensities of the korean or the vietnam wars the assumption of complete learning that underlies the rational expectations hypothesis in general and rw s version of the nc model in particular is especially troublesome when the model contains dummy variables that correspond to unique events

portfolio optimization with mental accounts we integrate appealing features of markowitz s mean variance portfolio theory mvt 4 and shefrin and statman s behavioral portfolio theory bpt into a new mental accounting 5 ma framework features of the ma framework include an ma structure of portfolios 6 a definition of risk as the probability of failing to reach the threshold level in each mental 7 account and attitudes toward risk that vary by account we demonstrate a mathematical 8 equivalence between mvt ma and risk management using value at risk var the ag9

optimal security design how should new securities be designed traditional theories have little to say on this the literature on capital structure and general equilibrium theories with incomplete markets take the securities firms issue as exogenous this paper explicitly incorporates the transaction costs of issuing securities and develops a model where the instruments that are traded are chosen optimally and the economy s market structure is endogenous among other things it is shown that the firm s income stream should be split so that in every state all payoffs are allocated to the security held by the group that values them most this abstract was borrowed from another version of this item

lottery players stock traders the behavior of stock traders and lottery buyers can teach us about our common aspirations thoughts and emotions and help answer many questions of finance

implications for gaap from an analysis of positive research in accounting based on extant literature we review the positive theory of gaap the theory predicts that gaap s principal focus is on control performance measurement and stewardship and that verifiability and conservatism are critical features of a gaap shaped by market forces we recognize the advantage of using fair values in circumstances where these are based on observable prices in liquid secondary markets but caution against expanding fair values to financial reporting more generally we conclude that rather than converging u s gaap with ifrs competition between the fasb and the iasb would allow gaap to better respond to market forces

bank regulation and international financial stability a case against the 2006 basel framework for controlling tail risk in trading books abstract in attempting to promote international financial stability the basel committee on banking supervision 2006 provided a framework that sought to control the amount of tail risk that large banks around the world would take in their trading books relative to their corresponding minimum capital requirements however many of these banks suffered significant trading losses during the recent financial crisis our paper examines whether the basel framework allowed banks to take substantive tail risk in their trading books without a capital requirement penalty we find that it allowed banks to do so and that its minimum capital requirements can be notably procyclical hence focusing on the way the basel framework sought to control the amount of tail risk in trading books relative to their corresponding minimum capital requirements our paper supports the view that it was not properly designed to promote financial stability we also discuss alternative regulatory frameworks that would potentially be more effective than the basel framework in preventing banks from taking substantive tail risk in their trading books without a capital requirement penalty

what is the optimal design for lottery linked savings programmes in this article we determine the optimal design of lottery linked savings lls programmes lls vehicles such as lottery bonds are financial instruments that preserve depositors principal but provide randomized variable returns to these depositors through periodic lottery drawings in lieu of the regular coupon payments traditionally received by bondholders this type of asset is very popular in europe we note that the framing of lls instruments is linked to their popularity and we attempt to elucidate that link and thereby determine the optimal structure of payments for lls programmes our goal is to frame lls programmes in a manner that both maximizes their investors satisfaction and preserves their ability to serve as inexpensive sources of capital for their issuers we demonstrate that the optimal pay off structure is characterized by a high level of skewness as investors are willing to accept a decrease in the small and medium prizes of the lottery in exchange for an increase in the grand pri

markowitz with regret abstract providing a framework to integrate regret as an additional decision criterion in markowitz s model of portfolio selection we propose two different views on regret an investor might feel regret with respect to the ex post best alternative either in terms of return or in terms of preference value under both views regret can be captured by adjusting the vector of expected returns or alternatively by adjusting the return covariance matrix retaining the tractability of the markowitz model the regret model however has very different implications for how asset characteristics affect optimal portfolios while the impact of the skewness of an asset is strengthened the impact of the variance shrinks moreover we show for a variety of real portfolios that the effects of regret on optimal portfolio weights and the ex ante return distribution are large

on portfolio choice with savoring and disappointment we revisit the model proposed by gollier and muermann gollier c muermann a 2010 optimal choice and beliefs with ex ante savoring and ex post disappointment management sci 568 1272 1284 hereafter gm in the gm model for a given lottery agents form anticipated expected payoffs and the set of possible anticipations is assumed to be exogenously fixed we propose sets of possible anticipations that are endogenously determined this permits us to compare and evaluate in a consistent manner lotteries with different supports and to revisit the portfolio choice problem we obtain new conclusions and interesting insights our extended model can rationalize a variety of empirically observed puzzles such as a positive demand for assets with negative expected returns preference for skewed returns and underdiversification of portfolios this paper was accepted by rakesh sarin decision analysis

experimental tests of the separation theorem and the capital asset pricing model a computer controlled multistage portfolio selection task was devised to test experimentally basic assumptions underlying the separation theorem and the capital asset pricing model although most of the subjects diversified among the three risky assets the introduction of a riskless asset did not have the effect predicted by the separation theorem nor were the subjects affected by systematic changes in the variance covariance matrix of the risky returns however performance improved as the reward was increased tenfold the capital asset pricing model capm proposed by william sharpe 1964 john lintner 1965 and jan mossin 1966 has been the predominant normative as well as positive theory for determining assets returns and prices in financial markets the capm has a wide range of implications for various financial issues including the allocation of risky assets price predictions performance indices and market efficiency tests as well as tools for corporate finance decisions such as capital structure costs of financial sources and prices of new issues during the last decade numerous theoretical studies have examined and extended the capm a most recent development is the

the long and short of it why are stocks with shorter runs preferred this article examines how consumers process graphical financial information to estimate risk we propose that consumers sample the local maxima and minima of a graph to infer the variation around a trend line which is used to estimate risk the local maxima and minima are more extreme the higher the run length of the stocks the consecutive number of upward or downward movements of a price series with identical mean variance skewness and kurtosis three experiments show that this leads to stocks with higher run lengths being perceived as riskier the run length effect importantly the run length effect is greater for investors who are more educated are employed full time trade more frequently have had longer experience trading and trade a wider range of financial instruments implications for the communication of financial products public policy and consumer welfare are discussed as are theoretical implications for the processing of visual and financial information and behavioral finance

behavioral portfolio theory we develop a positive behavioral portfolio theory bpt and explore its implications for portfolio construction and security design the optimal portfolios of bpt investors resemble combinations of bonds and lottery tickets consistent with friedman and savage s 1948 observation we compare the bpt efficient frontier with the mean variance efficient frontier and show that in general the two frontiers do not coincide optimal bpt portfolios are also different from optimal capm portfolios in particular the capm twofund separation does not hold in bpt we present bpt in a single mental account version bpt sa and a multiple mental account version bpt ma bpt sa investors integrate their portfolios into a single mental account while bpt ma investors segregate their port folios into several mental accounts bpt ma portfolios resemble layered pyramids where layers are associated with aspirations we explore a two layer portfolio where the low aspiration layer is designed to avoid poverty while the high aspiration layer is designed for a shot at riches

a theory of anticipated utility abstract a new theory of cardinal utility with an associated set of axioms is presented it is a generalization of the von neumann morgenstern expected utility theory which permits the analysis of phenomena associated with the distortion of subjective probability

the behavioral relevance of mental accounting for the pricing of financial options abstract the paper reports an experiment on the pricing of financial options arbitrage free option pricing is tested against three hypotheses based on mental accounting the data show that even with considerable experience unexploited arbitrage opportunities persist subjects do not seem to make the connections between the different investment possibilities as essential for arbitrage free pricing afp instead they act as if they associate the risky assets to the same mental account while the bond is treated separately this corresponds to the construction of a two layer portfolio of a risky and a safe layer in the behavioral portfolio theory of shefrin and statman j fin quant anal 35 2000 127

options and structured products in behavioral portfolios abstract options and structured products have no roles in mean variance portfolios but they have roles in behavioral portfolios behavioral portfolios are composed of mental account sub portfolios each associated with a goal such as retirement income or bequest investors optimize each mental account by finding the assets and asset allocation that maximizes the expected return of each mental account sub portfolio subject to the condition that the probability of failing to reach a preset threshold aspiration level not exceed a preset probability put options are useful in downside protection mental accounts whose goal is avoiding poverty whereas call options are useful in upside potential mental accounts whose goal is a shot at riches we also explore the roles in behavioral portfolios of option collars capital guaranteed notes and barrier range notes

an asset allocation puzzle this paper examines popular advice on portfolio allocation among cash bonds and stocks it documents that this advice is inconsistent with the mutual fund separation theorem which states that all investors should hold the same composition of risky assets in contrast to the theorem popular advisors recommend that aggressive investors hold a lower ratio of bonds to stocks than conservative investors the paper explores various possible explanations of this puzzle and finds them unsatisfactory copyright 1997 by american economic association

portfolio selection with mental accounts and background risk abstract das et al 2010 develop a model where an investor divides his or her wealth among mental accounts with motives such as retirement and bequest nevertheless the investor ends up selecting portfolios within mental accounts and an aggregate portfolio that lie on the mean variance frontier importantly they assume that the investor only faces portfolio risk in practice however many individuals also face background risk accordingly our paper expands upon theirs by considering the case where the investor faces background risk our contribution is threefold first we provide an analytical characterization of the existence and composition of the optimal portfolios within accounts and the aggregate portfolio second we show that these portfolios lie away from the mean variance frontier under fairly general conditions third we find that the composition and location of such portfolios can differ notably from those of portfolios on the mean variance frontier

portfolio selection through maslow s need hierarchy theory inspired by maslow s need hierarchy theory we construct a new portfolio selection framework using the bi level optimization technique in which the lower level need relates to safety low risk whi

household portfolio diversification a case for rank dependent preferences the proliferation of novel preference theories in financial economics is hampered by a lack of non experimental evidence and by the theories additional complexity which has not been shown to be critical in applications in this article i present arguments in support of preferences with rank dependency using the survey of consumer finances data i document two widespread patterns inconsistent with expected utility i many households simultaneously invest in well deversified funds and in poorly diversified portfolios of stocks and ii some households with substantial savings do not invest anything in equities i show that portfolio choice models with rank dependent preferences plausibly parameterized and under fully rational assumptions are quantitatively consistent with the observed diversification these results call for further efforts to integrate the models of rank dependent preferences in portfolio theory and asset pricing the decision theoretic literature has long acknowledged the shortcomings of the expected utility theory of von neumann and morgenstern 1944 several generalizations of the theory are inspired by the experimental evidence and aimed at improving its descriptive accuracy however there are few applications of new models of preferences in finance and expected utility continues to dominate the field 1 two principal hurdles slow the proliferation of novel preferences in financial economics first the lack of empirical non experimental or field data confirming that the behavior motivating non expected utilities is widespread outside the laboratory settings second the additional and often significant complexity of the alternative preferences which has not been shown to be critical in applications where the models based on expected utility fall short of reasonable predictions this article presents empirical and theoretical this paper was previously circulated under the title household portfolio diversification the paper has benefited from the comments of shlomo benartzi luca benzoni markus brunnermeier john dickhaut maria perozek raj singh hersh shefrin and workshop participants at minnesota finance bag lunch 2003 wharton conference household financial decision making and portfolio choice and 2003 summer meetings of econometric society i would like to thank cam harvey the editor and an anonymous referee for many helpful comments and suggestions a special thanks to jack kareken for comments and editorial help on an earlier draft i am grateful to donna zerwitz for editorial assistance the views expressed herein are those of the author and not necessarily of the federal reserve bank of minneapolis or the federal reserve system all errors and omissions are the sole responsibility of the author address correspondence to valery polkovnichenko finance 3 122 csom 319 19 th

keynes meets markowitz the trade off between familiarity and diversification we develop a model of portfolio choice to nest the views of keynes who advocates concentration in a few familiar assets and markowitz who advocates diversification we use the concepts of ambiguity and ambiguity aversion to formalize the idea of an investor s familiarity toward assets the model shows that for any given level of expected returns the optimal portfolio depends on two quantities relative ambiguity across assets and the standard deviation of the expected return estimate for each asset if both quantities are low then the optimal portfolio consists of a mix of familiar and unfamiliar assets moreover an increase in correlation between assets causes an investor to increase concentration in familiar assets flight to familiarity alternatively if both quantities are high then the optimal portfolio contains only the familiar asset s as keynes would have advocated in the extreme case in which both quantities are very high no risky asset is held nonparticipation this paper was accepted by brad barber teck ho and terrance odean special issue editors

international portfolio selection with exchange rate risk a behavioural portfolio theory perspective abstract this paper analyzes international portfolio selection with exchange rate risk based on behavioural portfolio theory bpt we characterize the conditions under which the bpt problem with a single foreign market has an optimal solution and show that the optimal portfolio contains the traditional mean variance efficient portfolio without consideration of exchange rate risk and an uncorrelated component constructed to hedge against exchange rate risk we illustrate that the optimal portfolio must be mean variance efficient with exchange rate risk while the same is not true from the perspective of local investors unless certain conditions are satisfied we further establish that international portfolio selection in the bpt with multiple foreign markets consists of two sequential decisions investors first select the optimal bpt portfolio in each market overlooking covariances among markets and then allocate funds across markets according to a specific rule to achieve mean variance efficiency or to minimize the loss in efficiency

applying regret theory to investment choices currency hedging decisions we apply regret theory an axiomatic behavioral theory to derive closed form solutions to optimal currency hedging choices investors experience regret of not having chosen the ex post optimal hedging decision hence investors anticipate their future experience of regret and incorporate it in their objective function we derive a model of financial decision making with two components of risk traditional risk volatility and regret risk we find results that are in sharp contrast with traditional expected utility loss aversion or disappointment aversion theories we discuss the empirical implications of our model and its ability to explain observed hedging behavior

savings and prize linked savings accounts abstract many households have insufficient savings to handle moderate and routine consumption shocks many of these financially fragile households also have the highest lottery expenditures as a proportion of income this combination suggests that prize linked savings pls accounts combining security of principal with lottery type jackpots can increase savings among these at risk households results from an online experiment show that the introduction of pls accounts increase total savings and reduce lottery expenditures significantly especially among individuals with the lowest levels of savings and income the results imply that pls accounts offer a plausible market based solution to encourage individuals to increase savings

electricity generation cost in isolated system the complementarities of natural gas and renewables in the canary islands abstract the canary islands offer an example of an isolated electric grid of relative important size within the eu due to its peculiarities the role of renewable energies and their complementarity with fossil fuels offers a solid path to achieving the main energy policy goals of the islands the purpose of this paper is to assess the current situation and the energy objectives proposed in the energy plan of the canaries pecan 2006 for the electricity industry taking into account the average cost and the risk associated with the different alternatives for generating electricity by means of the mean variance portfolio theory our analysis highlights the inefficiency of the current electricity generating mix in terms of cost risk and lack of diversification shifting toward an efficient system would involve optimizing the use of endogenous energy sources and introducing natural gas to generate electricity this scenario would mean reducing both cost and risk by almost 30 each as well as atmospheric co 2 emissions our results agree with the pecan philosophy

individual vs aggregate preferences the case of a small fish in a big pond we study the relationship between the risk preferences of individuals and the risk preferences of the aggregate economy to emphasize the vast differences that can occur between individual and market preferences brought about through aggregation we assume an economy consisting entirely of risk seekers we show that such individuals can lead to an aggregate economy that is risk averse the converse is also true an aggregate economy that exhibits risk aversion does not imply an economy of individual risk averters an economy demanding a risk premium can be formed from individuals who do not demand such compensation understanding the relationship between the preferences of individuals and the preferences of the aggregate economy is crucial for understanding the connection between the behavioral finance literature which focuses on individual preferences and the asset pricing literature which focuses on aggregate prices we discuss empirical implications of these results this paper was accepted by wei xiong finance

diversification and its discontents idiosyncratic and entrepreneurial risk in the quest for social status social status concerns influence investors decisions by driving a wedge in attitudes toward aggregate and idiosyncratic risks i model such concerns by emphasizing the desire to get ahead of the joneses which implies that aversion to idiosyncratic risk is lower than aversion to aggregate risk the model predicts that investors hold concentrated portfolios in equilibrium which helps rationalize the small premium for undiversified entrepreneurial risk in the model status concerns are more important for wealthier households consequently these households own a disproportionate share of risky assets particularly private equity and experience greater volatility of consumption consistent with empirical evidence diversification and risk sharing are fundamental principles of modern finance and macroeconomics however empirical evidence suggests that household portfolios are poorly diversified with many people reporting substantial holdings of a single stock for the wealthiest households large shares in closely held businesses constitute a particularly important source of risk e g heaton and lucas 2000a it is not surprising that entrepreneurs bear substantial undiversified risk since it is important for mitigating moral hazard and or adverse selection problems yet from a standpoint of portfolio theory entrepreneurship does not appear to be well compensated implying that many investors are willing to take poorly rewarded risks despite the availability of superior investment opportunities such as public equity that earns a large risk premium e g moskowitz and vissing j0rgensen 2002 hall and woodward 2007