Behavioral Operational Research in Portfolio Selection
Portfolio selection is the science of using operational research methods and techniques to select the best possible mix of assets in order to achieve the highest expected return while bearing the lowest risk. In this chapter we look at how this happens with the frame of Behavioral Operational Research (BOR). First we highlight the importance of BOR in portfolio optimization using cues from decision theory and psychology. Second we discuss the effects of behavior on portfolio optimization. We distinguish these effects as “structural” and “elemental”. Structural effects are caused by behavioral biases that change the structure of portfolio models. Elemental effects are those caused by behavioral biases that may affect variables, and parameters but not the structure of portfolio models. Third, we discuss how BOR can contain the above mentioned effects by discussing each piece of portfolio models individually and as a whole: expected return, risk, behavioral biases. Finally, we briefly review implications of our chapter and summarize our remarks.
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