Choosing investment solutions for South African long-term investors with prospect theory-type risk preferences
Date
2020-03
Authors
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Publisher
Stellenbosch : Stellenbosch University
Abstract
ENGLISH ABSTRACT : This thesis investigates the optimal choice of investment style for a representative long term
South African investor assuming a Prospect Theory-type utility functions. The relative performance of Balanced Funds, Absolute Return Funds, General Equity Funds, and Flexible
Funds were investigated in this context. A fundamental insight of Prospect Theory is that human
beings are more responsive to losses than gains, as demonstrated by the S-shaped value function.
These subtleties are ignored by Expected Utility Theory and their associated risk measures (most
importantly, variance) may lead to portfolio designs that are inconsistent with investors’ risk
preferences. Two methods for investigating the optimal investment style for these investors were
applied (namely, Historical Analysis and Filtered Historical Simulations). The Historical
Analysis method reveals that Balanced Funds offer the highest returns, but the Sharpe ratio
shows that Absolute Return Funds have the best risk-return trade off. Using Prospect theorybased
utility functions with differing parameters reflecting differing risk preferences, the Filtered
Historical Simulation method reveals that Absolute Return Funds are most likely to be the
optimal investment style for an investor exhibiting either severe or mild “loss aversion”. For
investors with “no loss aversion”, the optimal investment style is Balanced Funds which deliver
the highest expected cumulative utility. This study shows that the choice of investment style is
dependent on the level of loss aversion. This suggests the need to estimate these for South
African investors as the parameters used in this study are derived from international studies that
are relatively dated.
AFRIKAANSE OPSOMMING : Geen opsomming beskikbaar.
AFRIKAANSE OPSOMMING : Geen opsomming beskikbaar.
Description
Thesis (MCom)--Stellenbosch University, 2020.
Keywords
Investments, Foreign -- Strategic planning, Investments, Foreign -- Risk management, Investments, Foreign -- Decision making, Prospect theory, UCTD