Portfolio Life Cycle Selection – Theory and Experiment

In this paper, I compare the results from a laboratory experiment, in which individuals could allocate their funds between a risky asset and a risk-free zero return fund, with stochastic dynamic optimization policies based on expected utility maximization. Specifically, I focus on the predictions based on a negative exponential and concave quadratic utility. In addition, I look at the applicability of a rather exotic functional form to the experimental two security portfolio life cycle decision problem. However, the expected utility theorem has some implications which are not conform with field observations [Mar52], [Kah79], [Rab00], and [Rab01]. Therefore, an alternative theory [Kah79] is critically reviewed that avoids the less arguable implications of expected utility theory [Tve92]. Moreover, possible solutions are derived for a two asset portfolio decision problem in order to show the effects of the different models.