Multi-period Investment Strategies with Transaction Costs Under Cumulative Prospect Theory

Abstract

This paper focuses on optimal investment strategies under cumulative prospect theory (CPT). Considering transaction costs, we investigate CPT investors multi-period optimal portfolios. Our main contributions relative to previous work are expanding a single-period optimization problem to a multi-period optimization problem and investigating the impact of transaction costs on optimal portfolio selections. In a numerical analysis that applied original data on four stocks from the NASDAQ, we examine the effects of different risks on the optimal portfolio. Moreover, in contrast with the results without transaction costs, we come to conclusion that the optimal strategy with transaction costs is less sensitive to risk.

Portfolio optimization model with uncertain returns based on prospect theory

“…Calculation experiments show that by using this method, investors in CPT (cumulative prospect theory) display behavioral characteristics when facing a portfolio composed of risky assets. Deng et al [50] studied the multiperiod optimal investment portfolio considering transaction costs under cumulative prospect theory and analyzed the impact of transaction costs on the choice of optimal investment portfolio. Chang and Young [51] used the additional information provided by behavioral stocks to propose a portfolio selection model to produce a profitable portfolio superior to the traditional investment benchmarks (market indexes, mutual funds and exchange-traded funds).…”