Behavior Finance and Estimation Risk in Stochastic Portfolio Optimization

The objective of this paper is twofold. The first is to incorporate mental accounting, loss aversion, asymmetric risk-taking behavior, and probability weighting in a multi-period portfolio optimization for individual investors. While these behavioral biases have previously been identified in the literature, their overall impact during the determination of optimal asset allocation in a multi-period analysis is still missing. The second objective is to account for the estimation risk in the analysis. Considering 26 daily index stock data over the period from 1995 to 2007, we empirically evaluate our model (BRATE - Behavior Resample Technique) against the traditional Markowitz model