Behavioral portfolio theory bpt, put forth in 2000 by shefrin and statman, provides an. Behavioral portfolio theory hersh shefrin and meir statman, 2000 upside potential and downside protection. Behavioral portfolio theory with mental accounts nico singer may 4, 2011 abstract when goalspeci c asset selection is allowed optimal subportfolios do not necessarily. We integrate appealing features of markowitzs meanvariance portfolio theory mvt and shefrin and statman s behavioral portfolio theory bpt into a new mental accounting ma framework. Features of the ma framework include an ma structure of portfolios, a definition of risk as the probability of failing to reach the threshold level in. Van harlow iii, president and cio, strategic advisors, fidelity investments one edition of this work should be in every investment collectionchoice, h. In contrast, proponents of behavioral finance argue that behavioral costs are typically large, and cannot be addressed though incentives alone. Slides will be distributed during the first session. We develop a positive behavioral portfolio theory bpt and explore its implications for portfolio construction and security design.
In their behavioral portfolio theory, shefrin and statman 2000 develop a single and a. This alternative formulation, called maslowian portfolio theory mapt, yields the same results but adds some interesting insight and practical applications for the financial advisor. Behavioral portfolio theory journal of financial and. It is striking how well the findings of hersh shefrin and meir statman 2000 summarized in their behavioural portfolio theory are in agreement with the more general psychological theory about the hierarchy of needs as formulated by abraham h. Standard finance models assume a rational investor who is able to forecast prices in an unbiased fashion. Behavioral portfolio theory, journal of financial and quantitative analysis, 352, pp.
The optimal portfolios of bpt investors resemble combinations of bonds and lottery tickets, consistent with friedman and savages 1948 observation. Behavioral portfolio theory, introduced by shefrin and statman 2000, is. The disposition to sell winners too early and ride losers too long. For instance, he charges failed investors with committing heuristic bias or falling prey to representativeness. Hersh shefrin and meir statman, two leaders in the field of behavioral finance, attempted to explain the preference for the cash dividends anomaly in their 1984 paper, explaining investor preference for cash dividends. The case for behavioral portfolio theory retirement. It should be required reading for portfolio managers and traders. Statman 3, who considered the problem of compiling a portfolio from a behavioral point of view. Prospect theory has been widely supported by experimental studies of human behavior. Portfolio optimization with mental accounts journal of. Shefrin, statman 1985 the disposition to sell winners too early and ride losers too long. Shefrin and statman s behavioral portfolio theory bpt suggests that investors use mental accounting to match investment goals to asset allocations.
No other book so splendidly lays out the fundamentals of behavioral finance. What is behavioral finance meir statman, glenn klimek. Meir statman is the glenn klimek professor of finance at santa clara university. Belotti chair in the department of finance at santa clara universitys leavey school of business. When behavioral portfolio theory meets markowitz theory marie p elmann1, tristan roger2, olga bourachnikova3 abstract the behavioral portfolio theory bpt developed by shefrin and statman is often confronted to the markowitzs mean variance theory mvt. Its foundation blocks include normal behavior, behavioral portfolio theory, behavioral lifecycle theory, behavioral asset pricing theory, and behavioral market efficiency. Journal of financial and quantitative analysis 35 2, 127151, 2000.
Ingersollross theory of the term structure of interest rates, and the blackscholesmerton option pricing model, all of which are predicated on the emh in one way or another. Their combined citations are counted only for the first article. Perhaps the easiest way to think about their arguments and. Journal of financial and quantitative analysis, 2000, vol.
Oct 23, 2001 as such, either they treat behavioral costs as simply another form of agency costs, or they deny the relevance of cognitive errors. Statman, explaining investor preference for cash dividends 255. He also received a graham and dodd scroll award from the association for investment management and research, the. The optimal portfolio of a btp investor, which consists in a combination of bonds and lottery ticket, can differ from the perfectly diversified portfolio of markowitz. Each paradigm has attempted to better explain the movement of market prices. He is a pioneer of behavioral finance, and has worked on behavioral issues for over thirty years. Behavioral portfolio theory journal of financial and quantitative.
This book is about the second generation of behavioral finance. Behavioral portfolio theory by hersh shefrin, meir statman. Behavioral finance is the study of how psychology impacts finance. Journal of financial and quantitative analysis 35, 127151. Cambridge core institutional access books catalogue individuals. Behavioral finance is the study of how psychology affects financial decision making and financial markets. Portfolio theory describes how investors who make their decisions based solely on expected return the mean or average return and volatility standard deviation should make rational choices. The optimal portfolios of bpt investors resemble combinations of bonds and lotterly tickets consistent with friedman and savages 1948 observation.
Behavioral portfolio theory hersh shefrin and meir statman abstract we develop a positive behavioral portfolio theory bpt and explore its implications for portfolio construction and security design. In 1984, an article on dividends by professor shefrin and meir statman was the first treatment of behavioral finance by financial economists. The behavioral portfolio theory bpt developed by shefrin and statman 2000 is often set against markowitzs 1952 mean variance theory mvt. Journal of economic theory 129 2006 273288 gains and commonly convex for losses. Interview with professor meir statman about behavioral finance so when you sell it, it is 110. A central feature in behavioral portfolio theory rests on the observation that investors view their portfolios as sets of distinct mental account layers in a portfolio pyramid. We discuss the limits to arbitrage and then proceed to disc uss behavioral asset pricing theory, beha vioral corporate finance, and evidence. Layers are associated with distinct goals and covariances between layers are overlooked. Weighting function in the behavioral portfolio theory.
Interview interview with professor meir statman about. This cited by count includes citations to the following articles in scholar. Ethics, fairness, efficiency, and financial markets. Behavioral finance moves into its second generation. Theory and evidence disposition effect predisposition of investors to hold investment positions with paper losses too long and sell investment positions with paper gains too early. This book represents the first general, comprehensive treatment of the subject. How savings goal dynamics predict a reversal of the disposition effect. A behavioral approach to asset pricing 2nd edition.
The objective is to explain the key features of behavioral portfolio theory and the behavioral assetpricing model by means of conducting a comparative analysis of the mentioned theory and its. When behavioral portfolio theory meets markowitz theory. He attempts to understand how investors and managers make financial decisions and how these decisions are reflected in financial markets. First czech book about behavioral finance focusing on behavioral biases of individual investors. Journal of financial and quantitative analysis, 127151.
Meir statman glenn klimek professor of finance santa clara university. Another article by markowitz 1952b is part of the foundation of behavioral portfolio theory. Perspective on prospect theory with application to the asset allocation puzzle, working paper. The theory of risk return assessment through the utility theory was developed in the work by h. Behavioral portfolio theory volume 35 issue 2 hersh shefrin, meir statman. Although behavioral versions of utility theory kahneman and tversky, 1979, portfolio theory shefrin and statman. The optimal portfolios of bpt investors resemble combinations of bonds and lottery tickets, consistent with friedman and savages 1948. Behavioral portfolio theory downside protection upside potential a lotmore risk with some of your money behavioral finance behavioral portfolio theory hersh shefrin and meir statman, 2000 upside potential and downside protection lottery tickets and insurance. In particular, behavioral portfolio theory is consistent with the reluctance to have short and margined positions, an inverse relation between the bondstock ratio and portfolio riskiness, the existence of the home bias, the use of labels such as growth and income, the preference for securities with floors on returns, and the. We develop a positive behavioral portfolio theory bpt and explore its implications for portfolio constrution and security design. Behavioral portfolio theory, the journal of financial and quantitative analysis, 352, pp. Markowitzs 1952a meanvariance portfolio theory is one of three portfolio theories introduced in 1952 and the only one inconsistent with the friedman savage puzzle. Investors in behavioral portfolio theory construct their portfolios as layered pyramids where.
A valuable resource for both academics and practitioners, this authoritative collection brings together the main works in both psychology and finance, dealing with the debate between proponents of the behavioral school and advocates of the efficient market school. Hersh shefrin born in winnipeg, manitoba is a canadian economist best known for his pioneering work in behavioral finance. Each investor chooses a portfolio from the efficient frontier 10 based on his or her tolerance for risk. The ones marked may be different from the article in the profile. Although behavioral versions of utility theory kahneman and tversky, 1979, portfolio theory shefrin and statman, 2000, the capital asset pricing. You must not circulate this book in any other binding or cover and you must. At the university of waterloo in 1971 he received his m. Meir statman, a founder of behavioral finance, draws on his extensive research and the research of many others to build a unified structure of behavioral finance. Behavioral corporate finance by hersh shefrin ssrn. Hersh shefrin, meir statman we develop a positive behavioral portfolio theory bpt and explore its implications for portfolio constrution and security design.
Shefrins 2000 book beyond greed and fear is also recommended. According to shefrin, the financial community ignores the psychology of investing at its own peril. Beyond greed and fear is the first truly comprehensive behavioral finance book written for practitioners. We compare the bpt efficient frontier with the meanvariance efficient frontier and show that, in general, the two. Modern portfolio theory, meanvariance analysis expected returns, volatility of returns, capm. Socially responsible mutual funds corrected m statman. In that theory, investors divide their money into many mental account layers of a portfolio pyramid corresponding to goals such as secure retirement, college education, or being rich enough to hop on a cruise. The disposition effect behavioral finance the disposition. In that theory, investors divide their money into many mental account layers of a portfolio pyramid corresponding to goals such as having a secure retirement, paying for a college education, or being rich enough to hop. In the following sections, we discuss key areas in the a pplication of behavioral fina nce. Behavioral capital asset pricing model, journal of financial and quantitative analysis, 352, pp. Finance for normal people meir statman oxford university. The journal of financial and quantitative analysis, vol. In the 1970s and 1980s professor shefrin s coauthored papers in behavioral economics with richard thaler were the first to propose a psychological and neurological based theory of selfcontrol.
According to shefrin, lynch beat the market 11 out of years, and beat his nearest competitor by 6%. Understanding behavioral finance and the psychology of investing hersh shefrin abstract. Now, if the stock instead of going from 100 to 110 went from 100 to 60, then closing the account at a loss is going to be something that is going to impose regret. Behavioral portfolio management capital market theory has passed through two distinctly different paradigms in the past 80 years and is experiencing the rise of a third. Markowitz, 1952a, markowitz, 1959 described meanvariance portfolio theory and shefrin and statman 1987, 2000 described behavioral portfolio theory. Although the bpt optimal portfolio is theoretically not mean variance e cient.
Mvt and shefrin and statman s behavioral portfolio theory bpt into a new mental accounting ma framework. It will help practitioners to recognizeand avoidbias and errors in their decisions, and to modify. It suggests that investors have varied aims and create an investment portfolio. Shefrin offers juicy case histories, so his tour of behavioral finance is mostly enjoyable and useful.
Unlike the modern portfolio theory, a behavioral portfolio resembles a pyramid with distinct layers of well defined investment goals. Apr 16, 2017 a second edition of this book was published in 2008. According to shefrin 2000, three topics that underlie behavioral finance are heuristicdriven biases in predicting future market tendencies, framedependent investors preferences, and inefficient prices. Optimizing portfolio selection, which considers investors behavior was first proposed by shefrin and statman 2000 through the behavioral portfolio theory bpt. Beyond greed and fear illuminates behavioral finance for todays investor. It will help practitioners to recognize and avoidbias and errors in their decisions, and to modify and improve their overall investment strategies. We develop a positive behavioral portfolio theory and explore its implications for portfolio construction and security design. The behavioral portfolio theory btp developed by shefrin and statman 2000 considers a probability weighting function rather than the real probability distribution used in markowitzs portfolio theory 1952.
This study reveals the effect of psychological factors in investment decision making process. Beyond greed and fear hersh shefrin oxford university. In this paper, we compare the asset allocations generated by bpt and mvt without restrictions. Shefrin s 2000 book beyond greed and fear is also recommended. Shefrin h and m statman 1994 behavioral capital asset pric.
Sharpe award for scholarship in financial research from the journal of financial and quantitative analysis for his article behavioral portfolio theory, written with meir statman. Behavioral finance the disposition effect week 3 meeting 3 23. Direct application of prospect theory kahneman, tversky shefrin, statman 1985 the disposition to sell winners too early and ride losers too long. Explaining investor preference for cash dividends hersh m. A behavioral approach to asset pricing is the first behavioral. A second edition of this book was published in 2008.
People save and spend as described by behavioral lifecycle theory, where impediments, such as weak behavioral finance moves into its second generation by meir. At times, though, the book bogs down in the authors attempts to legitimize behavior finance, a relatively new school of thought. This paper aims to offer an alternative formulation of the behavioural portfolio theory as formulated by hersh shefrin and meir statman 2000 via the theory of needs from abraham maslow 1943. In 2008, after the publication of the first edition of this book, professor shefrin published a related book titled ending the management illusion, which described how behavioral corporate finance could be taught using a simulation game. Meanvariance portfolio theory is a construction theory. Shefrin h and m statman 1994 behavioral capital asset. What is behavioral finance what investors really want. Portfolios within the behavioral framework resemble layered pyramids. It suggests that investors have varied aims and create an investment portfolio that meets a broad range of goals. Behavioral portfolio theory behavioral portfolio theory, introduced by shefrin and statman 2000, is a goalbased theory. It provides the tools necessary for the construction of meanvariance portfolios to investors who care only about the expected returns of their portfolios and their risks. Each mental account corresponds to a particular want, associated goal, and their utilitarian, expressive and emotional benefits.
Behavioral portfolio theory bpt, put forth in 2000 by shefrin and statman, provides an alternative to the assumption that the ultimate motivation for investors is the maximization of the value of their portfolios. This article presents the evolution of behavioral finance, which is a new approach in capital market. Markowitz, 1959 described meanvariance portfolio theory and shefrin and statman 1987, 2000 described behavioral portfolio. Aug 17, 2019 modern portfolio theory mpt and behavioral finance represent differing schools of thought that attempt to explain investor behavior. Managing the psychology that drives decisions and influences operational risk shefrin, hersh on. Behavioral portfolios pension research council university of. The book explains how psychological phenomena impact the entire field of finance. In the 1970s and 1980s professor shefrins coauthored papers in behavioral economics with richard thaler were the first to propose a psychological and neurological based theory of selfcontrol. The journal of financial and quantitative analysis. The optimal portfolios of bpt investors resemble combinations of bonds and lotterly tickets consistent with. The two other portfolio theories, markowitzs 1952b customary wealth theory and roys 1952 safetyfirst theory, are consistent with the puzzle.