| Investors are divided into three groups in modern portfolio theory (MPT)
according to their risk preferences, which are assumed to be invariant ]
in any situations. However, as shown in many psychological tests, most
investors change their attitude toward risk when they are in different
situations. Especially, most investors are risk seeing when getting a
chance to recapture their losses in investments. MPT has not taken these
features into consideration in its models for portfolio choices and
portfolio rebalancing.
This paper is to propose a model for rational behavior in portfolio rebalancing. We first redefine the notion of rational behavior in investment, and then define the utility of an investment as a function of profit to describe investors' behavior under loss. Since most investors are risk averse when investment is producing a profit and risk seeking when investment is causing a loss, we propose a conditional function as the utility function for rational investors, and build an optimization model for portfolio rebalancing problems. Since our model captures investors' rational behavior more faithfully, rebalancing decision derived from this model should be more acceptable for investors. . |
Updated 07/09/2013