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The Impact of Financial Journal of Interdisciplinary Economics

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Behavioral Theory

Amen Aissi Harzallah1

Mouna Boujelbene Abbes1

Abstract
The aim of this article is to compare the portfolio optimization generated by
the behavioral portfolio theory (BPT) and the mean variance theory (MVT)
by investigating the impact of the global financial crisis on the asset allocation.
We use data from the Canadian Stock Exchange over the 2002–2015 period.
By comparing both approaches, we show that for any level of aspiration and
admissible failure, the BPT optimal portfolio will always contain a part of the
mean–variance frontier. Thus, in the case of higher degree of risk aversion
induced by typical BPT investors, the security set is located on the upper right
of the Markowitz frontier. However, even if the optimal portfolios of MVT and
BPT may coincide, MVT investors associated with an extremely low degree of risk
aversion will not systematically choose BPT optimal portfolios. Our results also
indicate the period of financial crisis generate huge losses in MVT portfolio values
that implies a lower expected return and a higher level of risk. Furthermore, we
point out the absence of the BPT optimal portfolio when potential losses are
higher during the 2008 global financial crisis.

Keywords
Behavioral portfolio theory, mean variance theory, portfolio optimization,
financial crisis, investment decisions

1
Laboratory URECA, University of Sfax, Sfax, Tunisia.

Corresponding author:
Amen Aissi Harzallah, Laboratory URECA, University of Sfax, Sfax 3018, Tunisia.
E-mail: amen-aissi@hotmail.fr
2 Journal of Interdisciplinary Economics

Introduction
Portfolio optimization is simply defined as the process of determining the weight-
ing of securities in a portfolio in order to yield the most favourable risk return
trade-off. Therefore, the characteristics of optimal portfolio are a key question for
both academics and financial practitioners.
In 1952, Harry Markowitz introduced the mean variance theory (MVT), which
is considered as the cornerstone of the modern portfolio theory. The asset alloca-
tion of MVT’s investors results from a trade-off between return and risk, where
the variance is a measure of risk. In other words, among the set of all possible
portfolios, MVT’s investors choose their optimal portfolio either by minimizing
the risk for a given level of expected return or by maximizing the return for a
given level of risk.
Despite its theoretical appeal, the mean-variance (MV) portfolio optimization
made the object of several critics. The major criticism relates to the use of the vari-
ance as a risk measure since it does not give a distinction between gains and losses
and supposes that the distribution of returns is symmetric and normal. See, for
example, Merton (1972), Li, Zhou, and Lim (2002), Bielecki, Jin, Pliska, and Zhou
(2005), Markowitz (2014), Cui, Gao, Li, and Li (2014), Yao, Li, and Li (2016), Ray
and Jenamani (2016), Bi, Jin, and Meng (2018) and Oliva and Renò (2018). To
address this shortcoming, Roy (1952) developed the safety-first approach and intro-
duced the downside risk measure as an alternative to the variance. This risk measure
takes into account the asymmetric nature of risk.
According to safety-first approach, the investors aim to minimize the probabil-
ity that the expected return fall below a given threshold. Further than Roy (1952),
Telser (1955) introduced the concept of the acceptable level for the probability of
ruin. In order to extend Roy’s safety-first concept, Telser (1955) introduced the
idea of an acceptable level for the probability of ruin. Moreover, Arzac and Bawa
(1977) extended Telser’s model by assuming an investor whose objective function
depends on the expected final wealth under this probability of failure. To better
integrate these different characteristics, Shefrin and Statman (2000) developed
the behavioral portfolio theory (BPT) as an alternative theory of portfolio choice.
This theory allows to fill the gaps between real life situations and classical theory
of Markowitz (1952) because it deals with the study of investor’s psychology and
its role in making investment decisions (Kapoor & Prosad, 2017).
In contrast with the foundation of MVT, the risk in BPT is measured by the
downside risk rather than by the variance of returns. In this context, the BPT
investors set a ‘safety-first’ constraint in order to ensuring their wealth in a maxi-
mum number of natural states. Furthermore, BPT investors did not behave ration-
ally in the market and took into account two conflicting emotions, namely, fear
and hope (Lopes, 1987). Moreover, BPT introduces another psychological bias
known under the name of mental accounting (MA) drawn from Kahneman and
Tversky’s (1979, 1992) prospect theory. Then BPT investors consider their port-
folio as a collection of sub-portfolios where each sub-portfolio is optimal for a
given mental account. Their portfolio can be considered as a pyramid of assets
where risky equities are in the top layer and the risk-free assets are in the bottom
Harzallah and Abbes 3

layer (each layer is associated with an aspiration level) (Magron, 2014). In their
seminal paper, Shefrin and Statman (2000) showed that the behavioral optimal
portfolio is typically not the Markowitz efficient portfolio.
However, several studies compared the asset allocation generated by MVT and
BPT and showed that some characteristics of MVT and BPT almost make their
asset allocations coincide. On the other hand M. Levy and Levy (2004) showed
that the prospect theory and Markowitz optimal portfolio sets can coincide even if
the prospect theory findings are in contradiction with the foundations of MVT.
By comparing the cumulative prospect theory (CPT) and the expected utility
theory, Levy, Giorgi, and Hens (2012) showed that the security market line theo-
rem of the capital asset pricing model is intact in the CPT framework. On their part,
Das, Markowitz, Scheid, and Statman (2010) developed a model by integrating
appealing features of the mean-variance portfolio theory and BPT into a new
framework, namely, the MA framework. They showed that optimal portfolios
within mental accounts and the corresponding aggregate portfolio are on the
mean–variance efficient frontier.
However, Alexander and Baptista (2011) show that the optimal portfolios
within accounts and the aggregate portfolio are generally away from the MV
frontier, by developing a mental account setting with delegation.
Furthermore, Baptista (2012) solve the problem of portfolio selection with
multiple mental accounts in the presence of background risk in each account.
He found that the aggregate portfolio is MV inefficient. However, Jiang, Ma, and
An (2013) indicated that the MV inefficiency of the aggregate portfolio is gener-
ally due to the lack of integration among the investment decisions in the markets.
As a result, they analysed international portfolio selection with currency risk
based on BPT.
On the other hand, Alexander, Baptista, and Yan (2017) complements the
study Das et al. (2010) by considering the estimation risk. They found that there
is a wide range of thresholds where optimal portfolios within accounts outperform
optimal portfolios in in the MVT with plausible risk aversion coefficients.
Recently, Yang and Liu (2018) propose goal-based portfolio selection model
with satisfied behaviour. Their model is modified according to CPT as well as
considering investors’ discounting preference in psychology.
Consequently, all these studies compare the asset allocation generated by MVT
and BPT by taking into consideration the MA bias and the safety-first criteria
of BPT.
Moreover, all these research studies hold that the stock returns are normally
distributed. However, some financial literature show that this assumption is
unrealistic (Brenner, 1974; Fama, 1965; Mandelbrot, 1963; Pfiffelmann, Roger,
& Bourachnikova, 2016; Walter, 2003; Young, Lee, & Devaney, 2006).
By considering that the asset allocation problems involve non-normally
distributed returns, Bourachnikova and Helmchen (2012) showed that MV
portfolio optimization and behavioral optimal portfolio produce very similar
outcomes. Furthermore, Hens and Mayor (2014) confirmed that the asset alloca-
tion of the CPT differs substantially from the MV analysis when the assumption
of normally distributed returns is rejected. More recently, Pfiffelmann et al. (2016)
4 Journal of Interdisciplinary Economics

used US stock prices from the CRSP database for 1995–2011 period and com-
pared the asset allocations generated by MVT and BPT without restrictions.
They showed that the BPT optimal portfolio is mean variance efficient in more
than 70 per cent of cases. They also determined a new optimal portfolio, namely,
the BPTCPT, and showed that this portfolio leads to similar results in terms of MV
efficiency.
Motivated by these earlier studies, this article aims at analysing the difference
between the MVT and the BPT in individual portfolio choices. Specially, we
investigate the impact of the investor’s behavioral bias, such as securities (fear)
and hope, on the asset allocation. In this empirical application, we use daily stocks
price data of the Canadian stock market ‘S&P/TSX 60’ over a period from January
2002 to December 2015. In order to investigate the impact of financial instability
caused by the 2008 global financial crisis on the asset allocations generated by
MVT and BPT, we need to decompose the study period into three sub-periods:
pre-crisis, crisis and post-crisis.
Traditionally, during the financial crisis, it is obvious that the portfolio theory
significantly underestimates risks, especially with regard to stocks. The financial
crisis of 2008 resulted in a decrease in preference for risky assets (Dharania,
Hassan, & Paltrinieri, 2019; Petmezasa & Santamaria, 2014; Ramb & Scharnagl,
2011). In addition, wealth fluctuations do appear to have a predictive power over
asset allocation, which strengthens the idea that households react as a response to
financial crisis.
The purpose of this article is to examine the effects of the financial crisis on the
portfolio composition and to investigate whether the investors have become more
reluctant to invest in the financial markets.
For each period, our approach consists in empirically estimating the portfolios
generated by MVT and by BPT with a limited number of assets and locating the
BPT portfolio in the same space of the Markowitz frontier. First, we generate a
universe of 100,000 possible asset allocations via a bootstrap simulation method.
Then, we need to solve the optimization programme of Shefrin and Statman
(2000) for three sub-periods to determine the optimal BPT portfolio among the
100,000 portfolios. Finally, we locate the BPT portfolios BPT in MV space in
order to compare them to Markowitz frontier.
The rest of the article is organized as follows. Section ‘Portfolio Optimization
Theories’ presents the Markowitz (1952) and the Shefrin and Statman (2000) opti-
mization models. Section ‘Data and Methodology’ provides the methodology and
data. Section ‘Results and Analysis’ illustrates the empirical results and the last
section concludes.

Portfolio Optimization Theories

In this article, we focus on the asset allocation and portfolio optimization for
two alternative theories: the Markowitz’s mean–variance theory and the BPT
developed by Shefrin and Statman (2000).
Harzallah and Abbes 5

The Mean–Variance Theory

The Mean Variance Theory of Markowitz (1952) has been recognized as the
cornerstone of modern portfolio theory. According to this theory, the investment
decision is characterized by two parameters of the returns distribution: the
expected return and the risk. Thus, the MVT investor seeks to minimize portfolio
variance for a given expected return. To solve this problem, the optimization
programme is defined as follows:

N N
Min *V (r) = | | v i, j x i x j 4
i=1 j=1

N
S\C E (r) = | n i x i = n p;(1)
i=1

N
| x i = 1;
i=1

x i $ 06i

where V(r) is the variance of the portfolio based on MVT, xi and xj are, respec-
tively, the weights of individual assets i and j, σij is the covariance between assets
i and j, ui and up are the expected returns of asset i and portfolio p, respectively,
and N is the number of risky securities.

The Behavioral Portfolio Theory

Shefrin and Statman (2000) developed the BPT by combining two theories of
choice under uncertainty, Lopes’ (1987) SP/A theory and Kahneman and Tversky’s
(1979, 1992) prospect theory. As a result, they proposed two versions of BPT, a
Single Mental Account Version (BPT-SA), which takes into account (the SP\A
theory) the safety-first concept of Lopes (1987) and a Multiple Mental Account
Version (BPT-MA), which introduces the psychological bias of MA structure
from the prospect theory.
In our study, we use the single account version of BPT build on SP\A theory.
Under this theory, the investor’s choice lies on an evaluation function SP (secu-
rity, potential) that relates to the emotions of fear and hope, as well as an aspira-
tion probability A. Lopes suggested that these two emotion functions are integrated
in the model by modifying the relative weights attached to decumulative probabil-
ities. On the one hand, the feeling of fear corresponds to the fearful investors
who underweights the probabilities attached to the best outcomes and overweighs
those of the worst outcomes. On the other hand, the hope emotion operates
through an overweighting of the small probabilities of the best outcomes for the
optimistic investors. Thereby, investors calculate their expected wealth by using
an inverse S-shape weighting function attached the decumulative probability
6 Journal of Interdisciplinary Economics

distribution of outcomes and by substituting E(W) with Eπ(W). In Lopes’ frame-

work, the aspiration factor generalizes the concept of the subsistence level where
investors aim at reaching a specific level. Therefore, the risk of the portfolio exists
when the probability is below this target value A.
According to Lopes’ (1987) theory, the BPT assumes that both contradictory
emotions drive the investor’s behaviour in the decision-making. Thus, the BPT
investors aim at maximizing their expected wealth while keeping the probability
of failure at threshold level A below a given α level. Therefore, the optimization
programme is defined as follows:

max E r _W i s.c.P _W ' Ai ' a(2)

where W is the final wealth distribution, A is the aspiration level, α is the accept-
able probability of ruin and π is a transformation function of the probabilities.
In this article, we assume that the investor takes into account the objective
probabilities, which indicates that π = id
R is a random variable defined as follows:

r = _W - W 0i /W 0(3)

Maximizing the expected final wealth, E (W) is the same as maximizing the
expected return on investment E (r).
According to Alexander and Baptista (2002), the aspiration level A of investor
is expressed according to the invested wealth W and a rate of return r*, such as:

A = W 0 _1 + r *i(4)

Taking into account Equations (3) and (4), hence, the optimization programme
of Shefrin and Statman (2000) becomes as follows:

max E _ri s.c.P _r ' r *i ' a(5)

where r is the random variable that corresponds to the portfolio return, r* is the
minimum return under which the individual does not want to fall and α denotes
the threshold of acceptable failure by the investor. Then, both r* and α are two
security parameters that characterize investor behaviour. Thereby, Shefrin and
Statman (2000) assumed that the investors choose their portfolios by taking into
their account expected wealth by desire for potential and security and aspiration
levels. In contrast, Markowitz (1952) assumed that the investors choose their
portfolio by considering the parameters of return and risk. However, the portfolio
selection in a BPT-SA theory is similar to those in an M-V theory, up to a point
(Shefrin & Statman, 2000).
In both frameworks, investors prefer higher expected returns with a lower vari-
ance (Var) and a lower probability of earning less than r*, P (r ' r *). Hence, the
Markowitz (1952) optimization problem is solved by maximizing the expected
return for a given level of variance but the BPT-SA optimal portfolios are obtained
Harzallah and Abbes 7

by maximizing the expected return given the probability α of earning below a

threshold value r*.

Data and Methodology

Data
The data set used in this article is composed of stocks listed on the Canadian
‘S&P/TSX 60’ index over the period from January 2002 to December 2015. We
eliminated the stocks with incomplete data during the considered period. Then,
our final sample contains 50 stocks from 60 companies listed at the Canadian
‘S&P/TSX 60’ index. We computed daily asset returns during the entire sample
period (2002–2015).

_Pit + D it - Pit - 1i
R it = (6)
Pit - 1
where Ri,t is the daily return of stock i for day t, Pit and Pit–1 are the stock prices,
respectively, at t and t – 1; Dit is the dividend of the security i over the period t.
Figure 1 plots the returns of the ‘S&P/TSX60’index over the entire study
period. It can clearly be observed that the returns are much more volatile for a
certain period relative to another. In fact, during the period from 2008 to 2010, the
return index showed an enhanced volatility reflecting the impact of the 2008
global financial crisis on the Canadian stock market. This finding supports the
results of Jayech, Sadraoui, and Ben Zina (2011) who reported the presence of a
financial contagion during the financial crisis of 2007 in the Canadian market.
As it is important for investors to know how a financial crisis shapes the
expected return and risk of portfolio, we have divided the entire sample period

Figure 1.  Time Plots of the Returns on the ‘SP/TSX 60’ Index
8 Journal of Interdisciplinary Economics

Figure 2.  Estimated Conditional Volatility of the S&P/TSX 60 Index

into three sub-periods, specifically before, during and after the crisis. Consequently,
we considered the period from 1 January 2002 to 30 June 2007 as the pre-crisis
period (1,135 observations of the daily assets returns). The period from 1 July
2007 to 31 July 2010 as the crisis period (774 observations of the daily assets
returns) and the period from 1 August 2010 to 31 December 2015 as the post-
crisis period (1,359 observations of the daily assets returns).
This decomposition made us evaluate the impact of the volatility variation
on asset allocation. We employed the Generalized Autoregressive Conditional
Heteroscedasticity model introduced by Engle (1982) to estimate the volatility
of Canadian stock market. The conditional volatility of the S&P/TSX 60 index is
given in Figure 2. This figure shows that the Canadian stock market had an
enhanced volatility from July 2007 to July 2010 period. Such pronounced volatility
is mainly caused by the occurrence of the 2008 global financial crisis, which is
considered as the most severe. Thereby, the conditional volatility of S&P/TSX 60
return increased and reached the peak during the financial crisis and then gradually
reverted over the following year.
Then, we present the descriptive statistics of daily stock returns for the pre-
crisis, crisis and post-crisis periods in Table 1.

Table 1.  Descriptive Statistics of Daily Returns

Standard Deviation ×
Mean × 10–3 10–3 Skewness Kurtosis
Panel A: Pre-crisis period
0.11 2.112 0.086 106.0125
Panel B: Crisis period
0.0399 2.898 – 0.2692 16.0413
Panel C: Post-crisis period
0.2089 1.8367 0.6425 90.1222
Harzallah and Abbes 9

The mean daily returns of securities revealed an extraordinary drop during the
crisis period. The highest returns were observed during the post-crisis period.
Moreover, during the crisis period, there was a higher volatility that involved a
steep fall of the standard deviation value followed by a quick recovery in the post
crisis. On the other hand, the returns of the securities were negatively skewed dur-
ing the crisis period, which indicated that the securities had more losses than gains
in this period. However, after and before the crisis, the returns were positively
skewed. During the three studied periods, the values of kurtosis were greater than
three. This result means that the normality hypothesis is rejected for the Canadian
stock market returns. Then, the asymmetry of the return distribution proved the
need for an alternative approach of portfolio choice, such as the BPT (Shefrin &
Statman, 2000). In this context, the BPT framework seems to be the most suitable
framework that takes into account the investor’s behaviour towards risk. In this
article, we investigate MVT and BPT frameworks by constructing an efficient
frontier and then comparing between the alternative models.

Methodology
By considering the asymmetry of the return distribution, we reject the hypothesis of
the normality of returns distribution, and then we compare the optimal portfolios
generated by BPT and MVT with a limited number of assets. To achieve our objec-
tive, we proceed by going through the three steps. First, we determine the necessary
number of securities that make up the final portfolio in such way that this portfolio
is perfectly diversified. Second, we estimate the expected annual returns via the
bootstrap method. Third, we generate a sample of 100,000 portfolios with different
numbers of stocks and weight distributions.

Step 1.The Diversification Effect

Several studies about the behavioral finance question the practical relevance of an
optimal portfolio composed of a large number of assets. For this reason, we try to
determine the sufficient number of assets to construct well-diversified portfolios.
According to Statman (2004), a well-diversified portfolio is the one that generates
at least 90 per cent reduction of variance relative to that of the portfolio composed
of two assets, namely, the least-diversified portfolio.
We follow the methodology of Campbell, Lettau, Malkeil, and Xu (2001) to
determine a good level of diversification, which can be achieved with a small
number of assets in the portfolio. Among the 50 assets, we randomly choose the
number of assets in a portfolio where n = 2, 3…50. For each value of n, we calcu-
late the average variance of 10,000 portfolios randomly constructed and com-
posed of n stocks with equal weights. The results of estimating the diversification
effect are given in Table 2.
Table 2 shows that a large number of stocks in the portfolio leads to a large
decrease of the portfolio variance. Furthermore, the risk is reduced when invest-
ments are evenly spread across several assets. For the three sub-periods, we find
that when the portfolio contains 14 assets, the variance is decreased by over 90 per
10 Journal of Interdisciplinary Economics

Table 2.  Diversification Effect for Different Levels of Volatility

Number of
Assets 2 4 6 8 10 12 14 20 30 40 50
The pre- 0.34 0.63 0.74 0.81 0.85 0.87 0.90 0.93 0.95 0.97 1.00
crisis
Reduction The crisis 0.36 0.63 0.75 0.81 0.86 0.88 0.91 0.94 0.97 0.98 1.00
of Variance period
The post- 0.36 0.63 0.74 0.81 0.84 0.89 0.91 0.95 0.97 0.99 1.00
crisis

cent compared to the least diversification scenario. Following Statman (2004), we

consider that a portfolio composed of 14 assets can reach a sufficiently high diver-
sification level. Thus, we randomly select 14 assets among the 50 making up our
sample in the three sub-periods. This number of stocks in the portfolio provides
sufficient diversification throughout the study period.
Step 2. Return Simulations Using the Bootstrap Method
In our empirical analysis, we randomly select 14 assets among the 50 making up
our sample. Then, we construct the matrix Rj (j = 1, 2 et 3) that contains the N
daily returns of the 14 randomly chosen stocks, where N denotes the number of
observations for each period (N = 1135, 774, 1359). Rj is given by:

A1 A2 f A 14
r1, 1 r1, 2 f r1, 14
R j = r2, 1 r2, 2 f r2, 14 (7)
f f f f
rN, 1 rN, 2 f rN, 14

where Ai denotes an individual asset i and rN,i denotes a daily return of asset i at
date N.
As our database contains daily returns, we use the bootstrap historical simula-
tion method of Hull and White (1998) to generate the possible scenarios of annual
returns. This method is a sampling process with replacement.
Excluding weekends and holidays, a year is on average made up of 250 trading
days (Hull, 2008). We randomly select 250 days among the N rows of matrix Rj.
Indeed, the first bootstrap sample includes 250 randomly sampled daily returns.
Thus, we construct the matrix of 250 daily returns of these 14 stocks prior to date
t. As the daily returns are logarithmic, we take the sum of the 250 daily returns
to compute the annual returns for each of the 14 chosen stocks. We repeat this
process 1,000 times to obtain the 1,000 states of nature for 14 assets. Finally, we
obtain a matrix R j* containing the 1,000 states of nature for the 14 stocks at date
t. R j*is defined as follows:
Harzallah and Abbes 11

A1 A2 f A 14
r1, 1 r1, 2 f r1, 14
R j* = r2, 1 r2, 2 f r2, 14 (8)
f f f f
r1000, 1 r1000, 2 f r1000, 14

Step 3. Generation of Portfolios

In order to provide a good diversity between the different portfolios, we should
generate portfolios depending on different numbers of assets and weight distribu-
tions. According to our study, the most diversified portfolio is the one that con-
tains 14 assets randomly selected, while the least diversified is the one which
contains just one stock among these 14 assets. Therefore, we consider a portfolio
of up to n assets where n ranges from 1 to 14. We assume that the part of the
wealth invested in an asset is equal to k/14 where k = 0, 1… 14. Table 3 presents
the number of generated portfolios according to the number of securities.
It is found that the total number of integer decompositions is equal to 20,058,286
portfolios for n = 14. Then, we randomly select 100,000 portfolios among the
20,058,286 possible ones. We obtain 100,000 different propositions of portfolios
with a different number of assets and weight distributions. In this case, we obtain
a matrix P* of dimension 100,000 × 14.

Results and Analysis

Impact of financial Crisis on the MVT Portfolios Optimization

The aim of this section is to investigate the optimization problem under the mod-
ern portfolio theory by considering the impact of the global financial crisis. In
order to estimate the optimal portfolios, we need to solve the Markowitz (1952)
optimization problem for each periods. In the Markowitz (1952) problem, the
programme suggests that investors aim at maximizing their expected returns
subject to an acceptable level of variance. The set of optimal portfolios is located
in the efficient frontier of Markowitz, which describes a frontline. This efficient
portfolios will have a higher expected return for a given level of risk or the lowest
risk for a defined level of return (Markowitz, 1959).

Table 3.  The Distribution of Portfolios

Number
of
Assets 2 4 6 8 9 10 11 12 13 14
Number 1,183 315,861 5,612,152 16,654,612 19,231,186 19,946,901 20058103 20,058,285
of 20,051,005 20,058,286
portfolios
12 Journal of Interdisciplinary Economics

Figure 3.  Impact of the Global Financial Crisis the Markowitz Portfolio Optimization

From the matrices R j*and P*, we compute the expected return and the standard
deviation for each portfolio of the 100,000 ones for the three sub-periods (before,
during and after crisis periods). In Figure 3, we present the 100,000 portfolios for
each period in the mean variance space. Each point in this figure represents one
portfolio of up to 14 assets. In order to investigate the impact of the global finan-
cial crisis on the Markowitz frontiers, we plot in Figure 3 the efficient frontier of
Markowitz (1952) for the three sub-periods. The results indicate that the financial
crisis induced both a notable increase of risk and a decrease of the expected return
on the 100,000 generated portfolios. Thus, the lowest negative return of MVT
portfolios can be seen in the crisis period.
We also observe that the global financial crisis has the worst influence on the
MVT portfolio optimization. Thus, the efficient frontier for the crisis period lies
below all the other efficient frontiers. Thereby, the expected returns of efficient
portfolios during the crisis period are lower for a given level of risk, compared to
the efficient portfolios before and after the crisis. These results indicate that the
financial crisis causes large drops of the market values of efficient portfolios cov-
ering risky securities. Consequently, this period is characterized by its negative
effect on the optimal portfolio selection for Canadian investors.

Impact of the Financial Crisis on the BPT Portfolios Optimization

For each of the 100,000 portfolios, we determine the BPT optimal portfolio that
meets the security constraint for the three sub-periods. Thus, according to Shefrin
and Statman, the optimal BPT portfolio is the one belonging to the security set,
which enables us to achieve the maximum value of the expected returns. Thereby,
the return on a BPT portfolio should not fall below level aspiration r* with more
Harzallah and Abbes 13

Table 4.  The Proportion of the BPT Portfolios

a = 0.3 a = 0.2; a = 0.1 a = 0

Panel A: The pre-crisis period
r* = 0 61.78% 46.26%; 25.86% 0.01%
r* = 0.05 40.05% 24.72%; 9.78% 0%
r* = 0.1 18.53% 8.85%; 2.02% 0%
Panel B: The crisis period
r* = 0 0.042% 0%; 0% 0%
r* = 0.05 0% 0%; 0% 0%
r* = 0.1 0% 0%; 0% 0%
Panel C: The post-crisis period
r* = 0 98.67% 93.73%; 71.99% 0.039%
r* = 0.05 91.90% 77.54%; 41.48% 0.001%
r* = 0.1 73.82% 50.95%; 15.32% 0%

than α probability. As each investor sets a ‘safety-first’ constraint different from

the other investor’s, we consider several configurations for α and r*. To solve this
problem, we consider 12 different specifications with r* ! {0; 0.05; 0.1} and α !
{0; 0.1; 0.2; 0.3}. For each existing optimal portfolio respecting the security con-
straint, we compute its standard deviation and expected returns for the three sub-
periods. The proportion of the BPT portfolio meeting the safety-first constraint
for different security parameters of α and r* is indicates in Table 4.
During the financial crisis period, the number of BPT portfolios is limited to 42
among the 100,000, which α = 0.3 and r* = 0. For the other scenarios, our results
indicate the absence of the BPT optimal portfolios, that is, none of the 100,000
portfolios meet the BPT security constraint. Therefore this period is characterized
by the lowest expected returns. As potential losses are too high during the finan-
cial crises, the ‘safety-first’ constraint leads BPT investors to refrain from choos-
ing any portfolio and decide against investing in the stock market. This result
shows that BPT investors are characterized by the emotions of fear and security.
For the periods before and after crisis, we show that for a given level of subsist-
ence, r*, the number of BPT portfolios that meets the security constraint increases
with the admissible probability of failure, α. This result seems quite natural, since
the BPT investor wants to secure more (fewer) states of nature when α decreases
(increases). Thereby, the terms of security set will contain fewer portfolios (α is
close to zero).
This finding confirms that BPT investors are characterized by emotions of
security and fear. Therefore, they become highly risk averse and wish to secure
their wealth. In this case, the BPT seems more likely to hold. For example, during
the post-crisis period when α is equal to 0.3 and the aspiration level is set its zero,
the proportion of portfolio that meets the constraint is 98.672 per cent. When
choosing α equal to 0 and the same aspiration level, this proportion decreases
by 0.039 per cent. This result indicates that the expectation of investor’s decreases
14 Journal of Interdisciplinary Economics

Figure 4.  Evolution of the BPT Portfolio Under Different Admissible Probability of
Failure for the Post-crisis Period

with α. Figure 4 plots the evolution of the BPT portfolio under different admissi-
ble probabilities of failure for the post-crisis period.
According to Figure 4, we notice that the BPT portfolios are always character-
ized by positive expected returns. Moreover, it is found that the investor who
requires more risk-aversion will build up a less risky portfolio, in terms of downside
risk measure.
Similarly, if the aspiration level r* increases when α remains constant, the
security set becomes smaller.
Therefore, for a lower level of admissible probability of failure or for a higher
level of aspiration, it is difficult to recover the portfolios satisfying the security
constraint. Where α = 0 and r* = 0, there are only 39 cases in which the investor
could reach his goal. When choosing r* equal to 0.05 and the same level of α, only
one portfolio meets this constraint. Finally, when r* increases by 10 per cent and
the same probability of failure, this scenario is still difficult where no portfolios
meets this constraint.
We can then note that the security parameters (r*, α) characterize the investor’s
behavioral risk function and determines the investment strategy. In fact, the
investment decision is made on both fear and hope emotions that operate on
the willingness to take risk drive investor’s behaviour. On the one hand, more
BPT investor is driven by fear, the more he needs to secure his wealth when he is
more risk averse. On the other hand, BPT investors are willing to take more
risks in order to have the chance to increase their potential gains when they
are less risk averse.
Harzallah and Abbes 15

Figure 5.  Comparison Between MV Efficient Frontier and the BPT Portfolios During
the Post-crisis Period

Comparison Between the MV Efficient Frontier and the BPT Portfolios

for the Post-crisis Period
We point out that the BPT portfolio is absent during periods of financial crisis.
Thereby, we compare the BPT portfolio to efficient portfolios chosen by Markowitz
investors for the post-crisis period.
In order to compare the two portfolios, we need to empirically locate the
BPT portfolio in the mean variance space. Figure 5 presents a comparison
between the MV efficient frontier and the BPT portfolio under different levels of
admissible failure (α = 0; 0.1; 0.2; 0.3) with subsistence level (r* = 0), during the
post-crisis period.
For various levels of admissible failure, we observe that the BPT portfolios
meeting the security constraints always contain a part of the Markowitz frontier.
Furthermore, we show that higher α is, the more the BPT optimal portfolios are
located on the extreme upper right part of the mean variance frontier. This implies
that these BPT portfolios are characterized by a very high level of expected returns
and high risk. Consequently, the BPT optimal portfolios coincide with those gen-
erated by Markowitz optimization programme.
According to Shefrin and Statman theory, all the secured portfolios are
identical in term of risk for the BPT investors, that is, their standard deviation can
take all the possible values. In both MVT and BPT approaches, we note that the
less risk averse the investor is, the riskier his optimal portfolio will be. Thereby,
a BPT investor who requires less security will build up a riskier portfolio (in
the sense of the downside risk measure and the variance). Indeed, in these cases,
this investor systematically selects a portfolio located on the efficient frontier of
Markowitz.
16 Journal of Interdisciplinary Economics

It is important to notice the result of the specific case when the probability of
failure and the aspiration level are equal to zero. The set of portfolios satisfying
this security constraint are paying less the wealth invested in any state of nature.
Then, in this case, the BPT investor is capable of recovering his initial wealth in
any state of nature creating a perfect insurance against any loss. Indeed, the BPT
investor chooses the portfolio that has the maximum return and the highest risk
relative to other portfolios located in the efficient frontier of Markowitz. However,
for the same level of return, the MVT investor chooses a portfolio located on the
efficient frontier with a lower level of risk compared to the BPT optimal portfolio.
This result confirms that the BPT allocation does not necessarily lead to the same
asset allocation generated by MVT even if the asset allocation of both approaches
coincides. This result implies that even if the BPT optimal portfolio is often situ-
ated on the efficient frontier of Markowitz (1952), it will not be chosen by MV
investors since it is associated with an extremely low degree of risk aversion.

Conclusion
This study investigates both different approaches in asset allocation, Markowitz’s
(1952) MVT and the BPT developed by Shefrin and Statman (2000). Our aim
consists of comparing the asset allocations of these two theories without restric-
tions. Simulations are run using the daily return of the Canadian stock index for
the 2002–2015 period. In order to investigate the impact of the global financial
crisis on the MVT and BPT asset allocation, we need to divide the sample period
into three sub-periods (before, during and after crisis). The archived results indi-
cate that the financial crisis induced both a notable increase of risk and a large
decrease of the expected return for the MVT portfolios. Moreover, it caused large
drops of the market values of efficient MVT portfolios covering risky securities.
Furthermore, we point out that our results indicated the absence of the BPT opti-
mal portfolio. This finding is mainly attributed to the concept of security and fear
which characterizes BPT investors when potential losses are very high.
Then, we determine the BPT optimal portfolio for the various levels of admis-
sible failure and aspiration. We found that the modification of the security param-
eter is consistent with the way BPT investors perceive risk. On the one hand, the
more demanding the investor, in terms of security, the more he is driven by fear
to secure his wealth. As a consequence, he becomes less demanding in terms of
security and willing to take risks to increase his potential gains.
Comparing the asset allocation constructed by BPT and MVT, we establish
that Shefrin and Statman’s (2000) optimal portfolio is located on the efficient
Markowitz frontier. In fact, notice a coincidence between MVT and BPT models.
Then, we found empirical evidence that the optimal portfolios of a BPT inves-
tor that require more security are situated on the upper right of the efficient
Markowitz’s frontier. Therefore, even if the BPT optimal portfolio coincides with
the efficient frontier of Markowitz (1952), it will not be systematically selected by
MVT investors since it is associated with an extremely low degree of risk aversion.
Harzallah and Abbes 17

Finally, we provide empirical evidence that MVT and BPT do not lead to the same
asset allocation since MVT investors use different levels of risk aversion to the
one studied by BPT investors.

Declaration of Conflicting Interests

The authors declared no potential conflicts of interest with respect to the research,
authorship and/or publication of this article.

Funding
The authors received no financial support for the research, authorship and/or publication
of this article.

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