Behavioral Portfolio Choice and Disappointment Aversion

Enrico Saltari, University of Rome La Sapienza. Italy
Giuseppe Travaglini

Abstract

The standard portfolio model predicts a large equity position for most

households. Empirical evidence shows however that household’s wealth is

characterized by a small proportion of risky assets. To solve this paradox, we

employ the axiomatic theory of disappointment aversion (DA) and …nd an

analytical solution to the portfolio problem when risk is "small". Our solution

ha a form very similar to the well-known formula of Samuelson and Merton:

under DA the optimal share of the risky security is proportional to the ratio

between the mean and the variance of the excess return, the coe¢ cient of

proportionality being the reciprocal of the risk aversion. However, the mean

and the variance do not depend on the original probabilities but on a new

probability distribution a¤ected by the degree of DA