Chapter 20: Traditional Asset Allocation Securities: Stocks, Bonds, Real Estate, and Cash
Financial Behavior: Players, Services, Products, and Markets. H. Kent Baker, Greg Filbeck, and Victor Ricciardi, editors, 359-377, New York, NY: Oxford University Press, 2017.
Posted: 9 Jun 2017 Last revised: 12 Jun 2017
Date Written: June 1, 2017
Asset allocation models have evolved in complexity with the development of modern portfolio theory, but they continue to operate under the assumption of investor rationality and other assumptions that do not hold in the real world. For this reason, academics and industry professionals make efforts to understand the behavioral biases of decision makers and the implications these biases have on asset allocation strategies. This chapter reviews the building blocks of asset allocation, involving stocks, bonds, real estate, and cash. It also examines the history and theory behind two of the most popular portfolio management strategies: mean-variance optimization and the Black-Litterman Model. Finally, the chapter examines five common behavioral biases that have direct implications for asset allocation: familiarity, status quo, framing, mental accounting, and overconfidence. Each behavioral bias discussion contains examples, warning signs, and steps to correct the emotional or cognitive errors in decision making.
Keywords: behavioral finance, behavioural finance, asset allocation, modern portfolio theory, mean-variance optimization, Black-Litterman model, familiarity, status quo, framing, mental accounting, overconfidence
JEL Classification: A12, D81, G00, G30, G10, M00, M10, M41
Suggested Citation: Suggested Citation