Uncertain Portfolio Adjustment Model with Background Risk and Loss Aversion

This paper deals with portfolio adjustment problem considering background risk, lossaversion and transaction costs simultaneously in an uncertain environment.Due to the complexity of security markets, situations arise where historical data fail to predict future returns, and expert estimates must be used instead.Based on the uncertainty theory, we first establish an uncertain mean-risk indexutility model with background risk, in which securityreturns and background asset returns are uncertain variables and subject to normaluncertainty distributions. Then the effects of changes in the mean of background asset and the loss aversion coefficient on optimal utility value are discussed. In order to study the effects of loss aversionand background risk on investment decisions, we present an economic analysis of investmentstrategies. Our analysis reveals that background risk influences not only portfolio selection but also the investor's effective loss aversion coefficient. The results show that the proposed portfolio model can indirectly expressinvestors' preferences by the different background asset returns. Furthermore, we provide comprehensive comparative statics analysis and demonstrate the interaction effects between background risk and loss aversion parameters.