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Efficiency Evaluation of Assets and Optimal Portfolio Generation by Cross Efficiency and Cumulative Prospect Theory

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Abstract

The paper proposes a portfolio selection approach based on cumulative prospect theory (CPT) that integrates data envelopment analysis (DEA). The CPT-based model has emerged as the best model in behavioral portfolio theory for incorporating decision-maker behavior in risk and uncertainty. We are using the quadratic value function suggested in the study of Gazioğlu and Çalışkan (Appl Financ Econom 21(21):1581–1586, 2011), which is the best alternative to the value function proposed by Kahneman and Tversky (Handbook of the fundamentals of financial decision making: Part I, World Scientific, 2013) in the literature. Based on the CPT value of each asset, we bifurcate the assets into two groups, top CPT value assets and bottom CPT value assets. To assess the cross-efficiency of the assets, we consider the CPT value and long-term return of each asset as outputs and the variance of the return as an input. We combine cumulative prospect theory with cross-efficiency and examine the psychological aspects of decision-makers in portfolio selection. The study used thirty listed stocks from the Nifty-50, the National Stock Exchange, India for empirical investigation. The empirical findings elucidate that the portfolios generated by the highest CPT value surpass those generated by the lowest CPT value. We demonstrate that the proposed approach can be a potential tool for portfolio selection by exhibiting that the selected portfolio delivers greater risk-adjusted returns in the financial markets.

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Notes

  1. We are considering ten assets in both the groups, top CPT value assets, and bottom CPT value assets, in our study. The user can choose how many assets are included in each group, and this choice will have no impact on the results.

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Acknowledgements

The authors are thankful to Professor Suresh Chandra, Ex-faculty, Department of Mathematics, IIT Delhi, India, for his suggestions on this work. The first author, Sweksha Srivastava, is supported by the Indraprastha Research Fellowship for Ph.D. candidates granted by Guru Gobind Singh Indraprastha University, New Delhi, India vide letter no. GGSIPU/DRC/2019/91/1798. We would like to thank the editor and the anonymous referees for their valuable suggestions, which helped us to improve the quality of the paper substantially. The authors are responsible for any remaining errors.

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Funding was provided by guru gobind singh inderprastha university (Grant Number GGSIPU/DRC/2019/91/1798)

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  1. University School of Basic and Applied Sciences, Guru Gobind Singh Indraprastha University Dwarka, Delhi, 110075, India

    Sweksha Srivastava & Abha Aggarwal

  2. University School of Automation and Robotics, Guru Gobind Singh Indraprastha University Dwarka, Delhi, 110075, India

    Pooja Bansal

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  1. Sweksha Srivastava
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Srivastava, S., Aggarwal, A. & Bansal, P. Efficiency Evaluation of Assets and Optimal Portfolio Generation by Cross Efficiency and Cumulative Prospect Theory. Comput Econ 63, 129–158 (2024). https://doi.org/10.1007/s10614-022-10334-7

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