Pompian, M. (2006): Behavioral Finance and Wealth Management – How to Build Optimal Portfolios That Account for Investor Biases

Abstract

In “Behavioral Finance and Wealth Management—How to Build Optimal Portfolios That Account for Investor Biases,” Michael Pompian summarizes results from the area of behavioral finance and shows how to construct optimal portfolios in the presence of biases. I recommend the book to anyone working in the field of portfolio management because it delivers a good overview of investors’ behavioral biases. The book is divided into 27 chapters which are organized in four parts. The first part is an introduction to the field of behavioral finance. Part 2 overviews the relevant literature of different behavioral biases and presents hands-on advice for practice. Case studies are presented in the third part. In the last part, original research of the author is presented. The first chapter includes the challenges to the two standard finance assumptions, rational markets and the homo oeconomicus. The most prominent researchers/figures in the area as well as their main contributions are introduced. Subsequently, the history of the field is presented, from its emergence to the most recent developments. The focus is on findings in microeconomics, since the aim of the book is to show the implications for private investors. Practical applications start in the third and final chapter of this part. This chapter introduces the framework for portfolio management. Instead of presenting an analytical framework, the author gives particular advice on how to diagnose behavioral biases within investors. The second part of the book presents the contribution of the book. Each of the 20 chapters presents one particular bias and its behavioral explanation. Additionally a concrete practical application shows the use of the bias in practical situations and outlines implications for investors for each bias. A thorough discussion of the relevant literature is held in each chapter. Also, practical advice is given, such as how