| Abstract: |
We examine a static one-risk-free-one-risky asset portfolio choice when the
investor’s well-being is affected by the anticipatory feelings associated to
potential capital gains and losses. These feelings can be manipulated by the
choice of subjective beliefs on the distribution of returns. However, the bias
of these endogenous subjective beliefs induces the choice of a portfolio that
is suboptimal with respect to the objective expected utility of final wealth.
We characterize the structure of these optimal beliefs. We first show that
optimal subjective beliefs must be degenerated with only two possible returns.
Moreover, under some weak conditions on the utility function, these two atoms
are at the lower and upper bounds of the objectively feasible returns. When
the intensity of anticipatory feelings is small, the formation of beliefs must
be biased in favor of optimism, which implies an increase in the equilibrium
demand for the risky asset. We also show that the optimal beliefs are
approximately independent of the investor’s degree of risk aversion. |