Optimal Investment with Transaction Costs under Cumulative Prospect Theory in Discrete Time

TL;DR

This paper derives explicit optimal investment strategies under cumulative prospect theory in a discrete-time setting with transaction costs, highlighting how costs and risk preferences influence investment decisions.

Contribution

It provides explicit solutions for optimal strategies under CPT with transaction costs and analyzes their economic implications.

Findings

Transaction costs significantly affect optimal investment strategies.

Risk aversion influences the trade-off between potential gains and losses.

Explicit strategies are derived for specific examples.

Abstract

We study optimal investment problems under the framework of cumulative prospect theory (CPT). A CPT investor makes investment decisions in a single-period financial market with transaction costs. The objective is to seek the optimal investment strategy that maximizes the prospect value of the investor's final wealth. We obtain the optimal investment strategy explicitly in two examples. An economic analysis is conducted to investigate the impact of the transaction costs and risk aversion on the optimal investment strategy.