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Quality & Quantity

, Volume 47, Issue 6, pp 3371–3389 | Cite as

Roots and effects of financial misperception in a stochastic dominance framework

  • Rosella Castellano
  • Roy Cerqueti
Article

Abstract

This work deals with the issue of investors’ irrational behavior and financial products’ misperception. The theoretical analysis of the mechanisms driving erroneous assessment of investment performances is explored. The study is supported by the application of Monte Carlo simulations to the remarkable case of structured financial products. Some motivations explaining the popularity of these complex financial instruments among retail investors are also provided. In particular, investors are assumed to compare the performances of different projects through stochastic dominance rules. Unreasonably and in contrast with results obtained by the application of the selected criteria, investors prefer complex securities to standard ones. In this paper, introducing a new definition for stochastic dominance which presents asymmetric property, we provide theoretical and numerical results showing how investors distort stochastic returns and make questionable investment choices. Results are explained in terms of framing and representative effects, which are behavioral finance type arguments showing how decisions may depend on the way the available alternatives are presented to investors.

Keywords

Stochastic dominance Behavioral finance Derivatives pricing Mispricing Structured products 

JEL Classification

C65 D81 G24 

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Copyright information

© Springer Science+Business Media B.V. 2012

Authors and Affiliations

  1. 1.Department of Economic and Financial InstitutionsUniversity of MacerataMacerataItaly

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