Hello,
I have some issues with the example. How do we calculate the weights for the optimal allocation according to the Behavioural Portfolio Theory (BPT Approach). I do not see a formula in the book. How do we obtain the 1,568,627 investment in layer 1 and the 431,373 in layer 3.
Is this calculation necessary for the exam?
Many thanks
Regards
^^Way too early to start studying…IMHO, just sayin. I’ll answer your question in February or March.
I do not have a choice. February until May I cannot take holiday, since it is quite a busy time. Probably have to work until 1-3 am every day and a few hours at the weekend as well. Might take 1 week off before the exam. So will be painful for me. That is the reason why I need to start studying so early
That’s obvious: there is no calculation shown, there are no formulas in the curriculum. Why on earth should this calculation be necessary for the exam?
If you’re interested in understanding the example. here’s one way to arrive at the solution. It’s difficult to say what is necessary or not for the exam.
Premise of BPT is that the BPT investor will always shoot for low risk in the safe layer and high risk assets in aspirational layer. The optimal portfolio of a BPT investor is a combination of “bonds or riskless assets” and highly speculative assets (this is described in the previous page in the curriculum before the example). Based on this here’s the math: L1 = investment in layer 1, L3 = investment in layer 3. Equation 1: L1 + L3 = 2 million, Equation 2: 1.01 L1 + (1-0.5) L3 = 1.8 million. Solve these two equations for L1 and L3 and you will get L1 = 1.568627 million L3 = 431,373.
The key to this is BPT investor will always go for L1 (and hence L3 as well) even though he could have just easily invested only in L2 and satisfied his objectives and constraints.
There’s no combination of L1 and L2 that satisfies the equations above (solve using L1 and L2 and you will see L2 weight goes negative).
Hope this helps.