RECENT ADVANCEMENTS IN THE BEHAVIORAL PORTFOLIO THEORY: A REVIEW

Abstract

The “modern” portfolio theory of the Nobel laureate Professor Harry Max Markowitz has not been too modern now-a-days. Not simply for that investors are not risk-averse but also for that the “risk-free rate of return” is not risk-free at all. The mean-variance returns are not free from effects of investors’ active investment time-scales. Further, at presence of the noise traders in the financial markets, the efficient frontier becomes inefficient. These flaws in the modern portfolio theory have led the development of the behavioral portfolio theory by Shefrin & Statman (2000). The recent advancements in the behavioral portfolio theory explain effects of investors’ task environments viz., psychological biases, preferences,and sentiment etc. evident at the general environment. The paper critically reviews the different facets of the behavioral portfolio theory: its theoretical, empirical, and experimental evidences, efficient and inefficient market microstructures, systematic and unsystematic risks diversifications, and mental accounting and physical accounting etc.