Rational distorted beliefs investor; which risk matters?

Author's Department

Economics Department

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https://doi.org/10.1016/j.frl.2022.103431

All Authors

Mohammed Bouaddi, Khouzeima Moutanabbir

Document Type

Research Article

Publication Title

Finance Research Letters

Publication Date

Winter 1-1-2023

doi

doi.org/10.1016/j.frl.2022.103431

Abstract

This paper considers a portfolio strategy in which the investor applies beliefs distortion to allocate different weights to different kinds of risk in the context of Markovitz portfolio. We assume that the investor decomposes the aggregate risk into three different components:fundamental observed factors’ risk, fundamental non-observed factors’ risk and idiosyncratic risk. Our distorted beliefs’ portfolio outperforms the traditional mean–variance and the naive portfolios. We also find that the rational investor prefers to bear more observed fundamental risk and minimize other risks.

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