Portfolio choice under cumulative prospect theory: sensitivity analysis and an empirical study

A sensitivity analysis of the impact of cumulative prospect theory (CPT) parameters on a Mean/Risk efficient frontier is performed through a simulation procedure, assuming a Multivariate Variance Gamma distribution for log-returns. The optimal investment problem for an agent with CPT preferences is then investigated empirically, by considering different parameters’ combinations for the CPT utility function. Three different portfolios, one hedge fund and two equity portfolios are considered in this study, where the Modified Herfindahl index is used as a measure of portfolio diversification, while the Omega ratio and the Information ratio are used as measures of performance.