Investors' Life Cycle Asset Allocation Theory

Asset Pricing and Asset Allocation are always the hotspots in the domain of finance.In the aspect of Lifecycle Asset Allocation for the individual investors, there are twodifferent views: Traditional Finance Theory and Behavior Finance Theory. As for theTraditional Finance Theory, individual investors follow CRRA (Constant Relative RiskAversion). Thus, the proportion of risk capitals in the asset allocation will decline as theinvestors grow. In the reality, however, the data indicate that the proportion of riskcapitals in Individual Investors Lifecycle Asset Allocation, turn to be "Hump Shape",which can not be explained in the Traditional Finance Theory.This essay, focusing on such abnorlnity, will illustrate the "Hump Shape" andundertake demonstration simulation on the basis of the Behavior Finance Theoryespecially the Prospect Theory. Here are the general contents and summaries:Firstly, this essay introduces the assumptions, characteristics and expressions ofConstant Relative Risk Aversion Utility Function, as the basis for the traditional theoriesAsset Pricing and Asset Allocation. Then, it introduces a traditional and classical AssetPricing Model: Lucas Model (1978), which then followed by the description ofConsumption Capital and Asset Pricing Model (CCAPM), obeying ConditionalLogarithmic Normal Distribution and whose utility function abides by Constant RelativeRisk Aversion (CRRA). Eventually, it explains the concepts and methods of the traditionalLifecycle Asset Allocation Model, which sets the Asset Allocation Models of Jagannathanand Kocherlakota as examples.Secondly, on the basis of BHS Model, this essay introduces a utility function modelbased on the Prospect Theory. After contrasting the CRRA, two characteristics ofProspect Theory Utility Function have been summarized.Lastly, this essay, which employs the Strategy Function based on Prospect TheoryUtility Function and imitates the thoughts of Cocco, Gomes and Maenhout (1999), tries todo some simulation by means of the data of one thousand investors. The simulatingresults show that all the proportion in the best asset allocation of individual investor'slifecycle under different culture backgrounds, turn to be Hump Shape, which is inaccordance with the practical data observed. Meanwhile, the values of bothσand b₀will influence the traces of stock proportion in the best Asset Allocation of Lifecycle.