A Behavioral Explanation of the Asset Allocation Puzzle

This paper combines a behavioral reward-risk model based on prospect theory with multiple investment accounts to explain the asset allocation puzzle, that is, the observation that investors violate the two-fund separation property of
optimal mean-variance allocations. In a empirical analysis with U.S. data, the authors show that investors with preference according to the behavioral reward-risk model and multiple investment accounts, invest a higher proportion into bonds and large cap stocks as their risk tolerance diminishes, consistently with the empirical findings.