On a model of portfolio selection with benchmark

Abstract

Evidently, the theoretical foundation of behavioural portfolio selection fundamentally differs from the concept of rational portfolio selection under uncertainty. Behavioural portfolio selection with respect to some given benchmark portfolio violates classical axioms of rationality. The paper proposes a unified behavioural model of portfolio selection, which incorporates rational portfolio selection as well as benchmarking and derives its analytical solution. In the model, the manager's utility function is based on regret theory and has two instead of one objective variable. The corresponding ‘EVC criterion’ helps to clarify controversial issues in portfolio selection and allows for testable implications.