Risk, Human Judgement and Asset Allocation

The classical expected utility maximisation theory for financial asset allocation is premised on the assumption that human beings when facing risk make rational choices. The theory has been challenged by many observed and repeatable empirical patterns as well as a number of famous paradoxes and puzzles. The prospect theory in behavioural finance use cognitive psychological techniques to incorporate anomalies in human judgement into economic decision making. This lecture explains the interplay between risk and human judgement, and its impact on dynamic asset allocation via mathematically establishing and analysing a behavioural portfolio choice model.