Behavioural Finance

[pb73]

In the CFAI reading Behaviour Finance Perspective Example 3, how 2000000 has been allocated between layer 1, 2 and 3?

 

[myriam2222]

The topic has been addressed here:
http://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91329140
However I still don’t get it.
The answer that is provided in this post is to say that layer 2 is excluded because it provides a return of 4.6% which is less than the 5% targeted. I don’t agree with this answer because, sure, it shows that layer 3 is necessary because it is the only one providing over 5% expected return, however, to reduce risk, it should be combined with either layer 1, or layer 2, or both.
If you exclude layer 2 it’s easy to come up with the weights of layer 1 and 3 to achieve the risk objective and return objective. But I still don’t understand why we would exclude it.

 

[cpk123]

investor 1 is a BPT investor - he does not like uncertainty in his returns - esp if it falls below his expected threshold value. (aspirational level)
From the passage just above the blue box in the curriculum

Quote:
“In the first layer, the investor seeks safety by buying bonds or riskless assets in order to insure his aspirational level of wealth with a small maximum chance of failure. In the second layer, the investor is willing to take risk with the residual wealth. In conse- quence, a BPT-optimal portfolio can differ from the rational diversified portfolio that is mean–variance efficient. In the BPT model, risk aversion is taken into account by the constraint that limits the risk of failing to achieve the aspirational level of wealth.”

 

[myriam2222]

I think I understand your point cpk123.
Given the text just above the blue box, it seems that we are just searching for two layers, as the investor has a mental accounting bias and is just thinking it terms of two layers: one to ensure safety, the other one to take more risk.
Considering that, it makes sense to take layers 1 and 3 for the second investor. But out of the context there would have been no reason to do that.