| Abstract: | The experimental results of prospect theory (PT) reveal suggestthat investors make decisions based on change of wealth ratherthan total wealth, that preferences are S-shaped with a risk-seekingsegment, and that probabilities are subjectively distorted.This article shows that while PT's findings are in sharp contradictionto the foundations of mean-variance (MV) analysis, counterintuitively,when diversification between assets is allowed, the MV and PT-efficientsets almost coincide. Thus one can employ the MV optimizationalgorithm to construct PT-efficient portfolios. |
