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When are two portfolios better than one? A prospect theory approach

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  • Luc Meunier

    (ESSCA School of Management)

  • Sima Ohadi

    (Odonatech)

Abstract

We investigate whether the display of portfolio performance as coming from one large portfolio or two smaller subportfolios matters to individuals and whether prospect theory can explain this preference. To this end, we run a large survey experiment of 3267 individuals in 5 European countries presenting an identical overall return as coming from one portfolio or two smaller subportfolios to individuals. We also elicited the coefficients of the prospect theory value function through price list lotteries. In losses, following prospect theory and mental accounting predictions, we observe emprically a preference for the display of returns as coming from 2 subportfolios, one displaying a small gain and the other a large loss, over a unique portfolio displaying the aggregated resulting loss. As expected, for an overall gain, individuals favor one portfolio over two subportfolios, one displaying a small loss and the other a larger gain. The shape of the value function does not explain individuals’ preferences. The reference point seems to be the main factor involved in explaining individuals’ choice of two subportfolio presentations of the outcome.

Suggested Citation

  • Luc Meunier & Sima Ohadi, 2023. "When are two portfolios better than one? A prospect theory approach," Theory and Decision, Springer, vol. 94(3), pages 503-538, April.
    • Handle: RePEc:kap:theord:v:94:y:2023:i:3:d:10.1007_s11238-022-09901-z
    DOI: 10.1007/s11238-022-09901-z
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