Prescriptive portfolio selection: a compromise between fast and slow thinking

Abstract

Purpose

The purpose of this paper is to develop a prescriptive portfolio selection (PPS) model based on a compromise between the idea of “fast” and “slow” thinking proposed by Kahneman.

Design/methodology/approach

“Fast” thinking is effortless and comfortable for investors, while “slow” thinking may result in better performance. These two systems are related to the first two types of analysis in the decision theory: descriptive, normative and prescriptive analysis. However, to compromise between “fast” and “slow” thinking, “overconfidence” is used as a weighting parameter. A case study including a sample of 161 active investors in Tehran Stock Exchange (TSE) is provided. Moreover, the feasibility and optimality of the model are discussed.

Findings

Results show that the PPS recommendations are efficient with a shift from the mean-variance efficient frontier; investors prefer PPS portfolios over the advisor recommendations; and investors have no significant preference between PPS and their own expectations.

Research limitations/implications

Two assumptions of this study include: first, investors follow their “fast” system of thinking by themselves. Second, the investors’ “slow” system of thinking is represented by advisor recommendations which are simple expected value of risk and return. Therefore, considering these two assumptions for any application is the main limitation of this study. Moreover, the authors did not have access to more investors in TSE or other financial markets.

Originality/value

This is the first study that includes overconfidence in modeling portfolio selection for the purpose of achieving a portfolio that has a reasonable performance and one that investors are comfortable with.

Citation

Momen, O., Esfahanipour, A. and Seifi, A. (2017), "Prescriptive portfolio selection: a compromise between fast and slow thinking", Qualitative Research in Financial Markets, Vol. 9 No. 2, pp. 98-116. https://doi.org/10.1108/QRFM-11-2016-0044