By Thorsten Hens
Content material:
Chapter 1 creation (pages 1–9):
Chapter 2 selection thought (pages 11–66):
Chapter three Behavioural Biases (pages 67–104):
Chapter four probability Profiling (pages 105–134):
Chapter five Product layout (pages 135–155):
Chapter 6 Dynamic Asset Allocation (pages 157–185):
Chapter 7 lifestyles Cycle making plans (pages 187–206):
Chapter eight established Wealth administration method (pages 207–227):
Chapter nine end and Outlook (pages 229–230):
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Additional info for Behavioural Finance for Private Banking
Sample text
This chapter aims to lay the foundation for the entire book. It focuses on three renowned models of decision theory: mean-variance analysis, expected utility theory, and prospect theory. We show how these theories differ and how to apply them to private banking. 1 INTRODUCTION Investing in financial markets amounts to selecting and combining lotteries. A lottery is described as “a set of consequences and the probability thereof’’. Simple lotteries arise, for example as the result of a coin tossing experiment.
To calculate the probability of a particular outcome, we first determine the set of possible consequences. e. c1 = 300, c2 = 500 and c3 = 700. The probabilities of all scenarios delivering these consequences are p1 = 1/3, p2 = 1/2, and p3 = 1/6, respectively. Thus, in the state-preference approach the lottery can be written as 1 1 1 L = 300, ; 500, ; 700, . 3 2 6 This correspondence between the lottery and the state-preference approach is innocuous if the probabilities of the states {p1 , . . , pS } are known by the decision-maker.
The mean-variance analysis and its equilibrium implication, the Capital Asset Pricing Model (CAPM), are widely praised in finance literature. For example Jagannathan and Wang (1996) consider them “ . . the major contributions of academic research in the post-war era’’. ’’ In general, the best portfolio for an investor is determined by two factors – the risk-return opportunities on the market and the investor’s preferences. e. the portfolios of risky assets with the minimum risk for a given expected return level (or the maximum return for a given risk level).