Beyond Mean-Variance: Portfolios with Derivatives and Non-Normal Returns in Mental Accounts

32 Pages Posted: 10 Mar 2011

See all articles by Sanjiv Ranjan Das

Sanjiv Ranjan Das

Santa Clara University - Leavey School of Business

Meir Statman

Santa Clara University - Department of Finance

Date Written: December 3, 2009

Abstract

Today's portfolios are often composed of mental accounts, one for each of an investor's goals. They often also contain derivative securities. We develop a methodology for optimizing mental accounting portfolios that contain derivatives and other securities with non-normal distributions of returns, including distributions with very fat tails. This methodology is especially urgent now, following the financial crisis of the last year which revealed that fat tails are indeed prevalent in return distributions. Derivatives o er protection from the disastrous losses of fat left tails.

Our approach is based on a simple preference metric, making it easy to implement. We consider puts, calls, collars, capital guaranteed notes, and other structured products. We show that employing derivatives in mental accounting portfolios results in material improvements in portfolios' risk and expected returns. We also show that some derivatives which are puzzling to mean-variance investors are attractive to mental-accounting investors.

Suggested Citation

Das, Sanjiv Ranjan and Statman, Meir, Beyond Mean-Variance: Portfolios with Derivatives and Non-Normal Returns in Mental Accounts (December 3, 2009). Available at SSRN: https://ssrn.com/abstract=1782309 or http://dx.doi.org/10.2139/ssrn.1782309

Sanjiv Ranjan Das (Contact Author)

Santa Clara University - Leavey School of Business ( email )

Department of Finance
316M Lucas Hall
Santa Clara, CA 95053
United States

HOME PAGE: http://algo.scu.edu/~sanjivdas/

Meir Statman

Santa Clara University - Department of Finance ( email )

500 El Camino Real
Santa Clara, CA 95053
United States
408-554-4147 (Phone)
408-554-4029 (Fax)

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