TY - JOUR
T1 - Failing to Foresee the Updating of the Reference Point Leads to Time-Inconsistent Investment
AU - Strub, Moris S.
AU - Li, Duan
PY - 2020/1
Y1 - 2020/1
N2 - The current literature on behavioral portfolio optimization with reference point updating assumes that the decision maker foresees how the reference point will evolve and thus solves a time-consistent problem formulation. Empirical findings, however, suggest that decision makers often fail to foresee the updating of the reference point and consequently make time-inconsistent decisions. We analyze and compare the optimal investment strategies for a discrete time behavioral portfolio optimization problem with loss-aversion and time-varying reference points under both the time-consistent and time-inconsistent framework and for different updating rules for the reference point. There is only one framework predicting realistic investment behavior: the decision maker fails to foresee the updating of the reference point and thus faces a time-inconsistent problem, solves for a dynamically optimal strategy, and updates the reference point in a nonrecursive manner.
AB - The current literature on behavioral portfolio optimization with reference point updating assumes that the decision maker foresees how the reference point will evolve and thus solves a time-consistent problem formulation. Empirical findings, however, suggest that decision makers often fail to foresee the updating of the reference point and consequently make time-inconsistent decisions. We analyze and compare the optimal investment strategies for a discrete time behavioral portfolio optimization problem with loss-aversion and time-varying reference points under both the time-consistent and time-inconsistent framework and for different updating rules for the reference point. There is only one framework predicting realistic investment behavior: the decision maker fails to foresee the updating of the reference point and thus faces a time-inconsistent problem, solves for a dynamically optimal strategy, and updates the reference point in a nonrecursive manner.
KW - reference-dependent preferences
KW - reference point updating
KW - time-inconsistency
KW - stochastic control
KW - portfolio selection
KW - prediction bias
KW - BEHAVIORAL PORTFOLIO SELECTION
KW - MYOPIC LOSS AVERSION
KW - PROJECTION BIAS
KW - PROSPECT-THEORY
KW - DYNAMIC INCONSISTENCY
KW - REALIZATION UTILITY
KW - CHOICE
KW - MONEY
KW - ADAPTATION
UR - http://www.scopus.com/inward/record.url?scp=85084826812&partnerID=8YFLogxK
UR - https://www.scopus.com/record/pubmetrics.uri?eid=2-s2.0-85084826812&origin=recordpage
UR - http://gateway.isiknowledge.com/gateway/Gateway.cgi?GWVersion=2&SrcAuth=LinksAMR&SrcApp=PARTNER_APP&DestLinkType=FullRecord&DestApp=WOS&KeyUT=000509473400011
U2 - 10.1287/opre.2019.1872
DO - 10.1287/opre.2019.1872
M3 - 21_Publication in refereed journal
VL - 68
SP - 199
EP - 213
JO - Operations Research
JF - Operations Research
SN - 0030-364X
IS - 1
ER -