Journal of Behavioral Finance
Vandenbroucke, J. (2015), A cumulative prospect view on optimized portfolios that hold structured products”, Journal of Behavioral Finance. DOI 10.1080/15427560.2015.1095750
In a nutshell
Structured products are a combination of fixed income instruments and options. Researchers often wonder why such investments sell at a premium compared to the value of its components.
The current publication analyses how the presence of structured products in optimized portfolios can be understood. The investor is assumed to take decisions in line with a popular behavioral model, known as prospect theory. Prospect theory has a proven track record in being able to understand actual decision making, where the classic rules of rationality fail.
Key features of the behavioral model indeed turn out to drive the presence of structured products in optimized portfolios. Most important is the tendency of investors to put a stronger weight to poorly probable outcomes such as extreme gains and losses. Once structured products enter the portfolio due the previous feature, the investor’s level of risk aversion determines their actual allocation.