behavioral portfolio theory

A BPT investor maximizes expected wealth subject to a safety constraint.

A mean variance efficient investor also maximizes expected wealth subject to a investment constraint.

Isn’t BPT investor similar to mean variance efficient investor?

Nope. The keywords are safety constraint versus investment constraint. Safety constraint is associated with a loss aversion attitude that is more in line with behavioral finance. Taking this approach into consideration results in a portfolio constructed in layers seeking to minimize potential losses and increase the dollar safety margin associated with funding the most important goals (think personal and market buckets). On the other hand aspirational goals would be funded with risky assets, and ultimately there would be no optimization between all these layers. The resulting portfolio would not be on the efficient frontier and would not be a mean variance efficient portfolio as it wouldn’t take into consideration the correlation between the layers. Investment constraint in this context is more related to a rational economic man seeking an optimal risk adjusted return, based on risk aversion and utility maximization.

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the if you go forward in evolution a little you get prospect theory… kaboom mind blown…

lol AlmostDoneIII, that’s L3 for you. Topics are no longer separated silos of thought, everything is portfolio management :stuck_out_tongue:

well written explanation. thank you

You are very welcome!