The financial crisis effects on asset allocation: Markowitz theory vs. behavioural portfolio theory

Abstract

This article focuses on two alternative theories of portfolio optimisation namely the mean variance theory (MVT) of Markowitz (1952) and the behavioural portfolio theory (BPT) of Shefrin and Statman (2000). Using stock prices from the Canadian Stock Exchange database for the 2002-2017 period, we attempt to compare the asset allocations generated by MVT and BPT frameworks by investigating the effect of the financial crisis. Our results indicate the financial crisis caused large drops of the market values of efficient MVT portfolios covering risky securities and the absence of the BPT optimal portfolio. This finding is mainly attributed to the concept of security and fear that characterises BPT and MVT investors. We also found out that the modification of the security parameter was consistent with the way BPT investors perceived risk. Thus, in the case of higher degree of risk aversion induced by BPT investors, we show that the security set is located on the upper right of the mean variance (MV) efficient. However, even if the asset allocations of MVT and BPT coincide, MV investors displaying lower degrees of risk-aversion don't systematically select the BPT optimal portfolios.