Investment Horizon and the Attractiveness of Investment Strategies: A Behavioral Approach
Posted: 15 Sep 2009 Last revised: 26 Mar 2010
We analyze different investment strategies by comparing them over a variety of investment horizons. As expected Utility Theory cannot explain the attractiveness of empirically observed strategies, we apply a behavioral approach instead. In particular, we assess attractiveness from the viewpoint of an investor with preferences described by Cumulative Prospect Theory (CPT), currently the most prominent descriptive theory for decision making under uncertainty. A bootstrap technique is applied using historical return data from 1926 to 2008. To allow for variety in investors’ preferences, we conduct several sensitivity analyses and further provide robustness checks for the results. In addition, we analyze the attractiveness of the investment strategies based on a set of experimentally elicited preference parameters. Our study reveals that strategy attractiveness substantially depends on the investment horizon. While for almost every preference parameter combination a bond strategy is preferred for the short run, stocks show an outperformance for longer horizons. Portfolio insurance turns out to be attractive for almost every investment horizon. Interestingly, we find probability weighting to be a driving factor for insurance strategies’ attractiveness.
Keywords: Behavioral Finance, Cumulative Prospect Theory, Portfolio Choice, Investment Strategy, Investment Horizon
JEL Classification: D14, D81, G11
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