Academic journal article Global Business and Management Research: An International Journal

Portfolio Choice in Emergent Markets: Between the Rational and the Behavioral Theories

Academic journal article Global Business and Management Research: An International Journal

Portfolio Choice in Emergent Markets: Between the Rational and the Behavioral Theories

Article excerpt


Modern portfolio theory is indeed modern, dating back to the late 1950s and early 1960s (Statman, 2005). It derives of an idealistic design: investors are rational (Miller and Modigliani, 1961), markets are efficient (Fama, 1965), Expected returns are a function of risk and risk alone (Sharpe, 1964) and investors behave in conformity of the mean-variance theory prescribed by Markowitz (1952, 1959).

Markowitz supposes that investors are always risk-averse and they use a practical tool which is the mean-variance optimizer in order to maximize their utility function which has a concave form for all investors. He postulates that the portfolio choice is a trade-off between two factors: risk and return. However, empirical evidences show that those assumptions are far from the reality.

The Friedman and Savage's (1948) puzzle which postulates that people who buy insurance often buy lottery tickets as well, the prospect theory which is grounded on the paper of Khaneman and Teversky (1979) and which argues that the utility function is S-shaped and the Lopes (1987)'s SP/A theory which predicts that emotions (fear and hope) affect investor's decision making. Shefrin and Statman (2000), found the Behavioral Portfolio Theory (BP/T). A theory that predicts that the Behavioral Portfolio has the shape of a pyramid that contains essentially two layers: the downside protection layer and the upside potential layer. The downside protection layer's aim is the protection from poverty and the upside potential layer's aim is growth.

We endeavor within this paper to:

* Test the theoretical predictions of the Behavioral Portfolio Theory in the Tunisian context.

* Develop the notion of the Safety aim and the Potential aim and their determinants.

* Isolate some determinants of the behavioral portfolio choice.

Literature review

Do investors follow a mean-variance approach or a behavioural one?

The utility function used in a mean-variance approach is concave reflecting a risk-aversion attitude of an investor. In contrast, the Behavioral portfolio theory affirms that investors react in conformity to the prospect theory (Khaneman and Teversky, 1979). They reason in term of gains and losses. They are risk-averse in the domain of gains while they are risk seeking in the domain of losses.

Beyond the Mean-variance portfolios; which are constructed as a whole, and only the expected return and the variance of the entire portfolio matter. Behavioral Portfolios are constructed not as a whole but layer by layer, where each layer is associated with a goal and is filled with securities that correspond to that goal. Covariance between assets is overlooked (Shefrin and Statman, 2000 and 2003).

The mental accounting (Thaler, 1985) argue that a human being, in a first step, segregate assets into different pockets and in a second step, he evaluates the risk of each asset and covariance between assets don't really matter. We focus on these points to valid the predictions of the behavioral portfolio theory.

Possible determinants of the Behavioral Portfolio choice

In attempt to find the determinants of portfolio choice, Frijns, Koellen and Lehnert (2006) present in their empirical research three models in order to incorporate both modern finance and behavioral finance. Ours study is oriented primarily towards the determinants of the behavioral portfolio choice. Several factors can affect this choice. In what follows, we discuss these factors. The age variable finds its origins in the early literature of Samuelson (1969) and Merton (1969). According to the first theoretical life-cycle asset allocation model, the optimal portfolio is still unchangeable among the individual's life-cycle. The empirical results are mitigated. While, Campbell (2000) affirms that younger investors are always more prone to invest in risky asset other research go on the other way. …

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