BEHAVIOURAL PORTFOLIO THEORY.pptx

BPT

1. BEHAVIOURAL PORTFOLIO THEORY SUHASINI MODI 218070592159 RISHI PATEL 218070592077 SHIVANI MODI 218070592153

2. Behavioural portfolio theory (BPT) is an investment theory that seeks to explain how and why investors make the decisions they do when constructing a portfolio. The theory posits that there are certain behavioural biases that lead investors to make suboptimal decisions, which in turn leads to lower returns. Definition:

3. Introduced by Hersh Shefrin and Meir Statman , behavioural portfolio theory is a goal - based theory . In this theory , investors divide their money into several mental account layers , arranged as a portfolio pyramid . Each layer corresponds to a specific goal such as buying a house , paying for children's education , having a secure retirement , or being affluent enough to go on a world tour whenever one chooses to . INTRODUCTION

4. HISTORY:- The seeds for behavioural portfolio theory were sown when Milton Friedman and Henry Savage noted , way back in 1948 , that human behaviour is guided by a desire to seek protection from adversity as well as a hope for riches . That is why people buy insurance policies as will lottery tickets . The seeds for behavioural portfolio theory were sown when Milton Friedman and Henry Savage noted , way back in 1948 , that human behaviour is guided by a desire to seek protection from adversity as well as a hope for riches . That is why people buy insurance policies as will lottery tickets .

5. PORTFOLIO THEORY: Portfolio theory provides a broad context for understanding the interactions of systematic risk and reward. It has profoundly shaped how institutional portfolios are managed and motivated the use of passive investment management techniques. The mathematics of portfolio theory is used extensively in financial risk management and was a theoretical precursor for today’s value-at-risk measures.

6. The silent features of the behavioural portfolio theory are as follows: Investor have several goals such as a safety, income, and growth often in that sequence. Each layer in the pyramid represents assets meant to meet a particular goal . The bottom layers of the pyramid are meant to guarantee financial survival and the upper layers offer upside potential with attendant volatility. Investors have separate mental accounts for each investment goal and they are willing to assume different levels of risk for each goal . Risk is managed by matching different assets to different investment objectives . The asset allocation of an investor's portfolio is determined by the amount of money assigned to each asset class by the mental accounts .

7. The co - variation of returns between different asset categories and individual securities is largely ignored . Investors end up with a variety of mini - portfolios as they overlook interactions among mental accounts and among investment assets . Diversification stems from investor goal diversification , not from purposeful asset diversification as recommended by Markowitz's portfolio theory . This means that most investors do not have efficient portfolios . They may be taking too much risk for the returns expected from their portfolio . Put differently , they can earn higher expected returns for the level of risk they are taking .

8. MENTAL ACCOUNTING: Sanjiv Das, Harry Markowitz, Jonathan Scheid, and Meir Statman, combined mean-variance portfolio theory and behavioural portfolio theory to develop mental accounting portfolio theory. Mental Accounting is the process by which people organize , evaluate and keep track of their financial activities. It is a cognitive process of accounting by which individuals segregate their money into separate accounts based on some subjective criteria .

9. Mental accounting is a habit which is frequently practiced by many individuals on a daily basis , for instance , people have a separate fund set aside for special purposes even when they have a substantial sum kept in their saving account . This special purposes are the expenditures that are considered extremely important such as a long due vacation , child's education , medical expenses , marriage , retirement savings or any other vital expenses .