CONTEMPORARY ISSUES IN
FINANCE 2025 - PART 2
Chapter 1: Digital household finance - positioning...................................................................................3
1.1. CIF: Corporate finance & household finance...................................................................................3
1.2. Recent European initiatives to improve financial wellbeing at societal level.................... 3
1.2.1. Belgian example: Pensiontest..................................................................................3
1.2.2. Financial literacy..................................................................................................... 3
1.2.3. Financial Resilience................................................................................................. 4
1.2.3.1. Europe’s “Retail Investment Strategy”............................................................ 4
1.2.3.2. Europe’s “Savings and Investments Union”.................................................... 5
1.2.3.3. Regulatory and supervisory initiatives............................................................ 5
1.3. Motivation to focus on (digital) investing...........................................................................7
1.3.1. 3 recent analyses.....................................................................................................7
1.3.1.1. How technology has the potential to increase financial welfare......................7
1.3.1.2. How technology has the potential to boost financial inclusion...................... 10
1.3.1.3. How technology may also challenge financial welfare..................................10
1.3.2. The rise of the retail investor..................................................................................13
1.3.2.1. FSMA Retail investor Dashboard..................................................................14
1.3.2.2. Efficient of financial markets (Eugene Fama).............................................. 15
1.3.2.3. The inefficiency of markets........................................................................... 16
1.3.2.4. The inelastic market hypothesis....................................................................16
1.3.3. The emotional component of investing.................................................................. 17
1.3.3.1. Digital conversion..........................................................................................17
1.3.4. The behavioral design of financial services........................................................... 18
1.3.4.1. Nudging - choice architecture....................................................................... 19
1.3.4.2. Behavioral design for digital financial services............................................. 19
1.4. Behaviour finance and the enhancement of traditional finance...................................... 21
Chapter 2: Digital household finance - People: Profiling investors..................................... 22
2.1. Expected value (Sint-Petersburg paradox).....................................................................22
2.2. Expected utility (rules of rationality)................................................................................ 23
2.2.1. Development of the Expected Utility Framework................................................... 23
2.2.2. Challenges for the Expected Utility Framework..................................................... 24
2.2.2.1. Consistent and predictable violation of the “rules of rationality”....................24
2.2.2.2. “Your actions reveal your preferences.” BUT: The case of organ donation..24
2.2.2.3. “People don’t choose between things but between the representation of
things.”....................................................................................................................... 24
2.2.3. Relevance in the context of household finance..................................................... 25
2.3. Prospect utility (reference point, loss aversion, probability weighting)........................... 25
, 2.3.1. Prospect Utility – probability weighting.................................................................. 25
2.3.2. Prospect Utility – functional form........................................................................... 26
2.4. Use case: investor risk profiling...................................................................................... 26
2.4.1. Improve in content................................................................................................. 27
2.4.1.1. Book: Thinking Fast and slow....................................................................... 28
2.4.2. Improve in Method................................................................................................. 28
2.4.3. International Research On “Financial Personalities”..............................................29
2.4.3.1. What did we measure?................................................................................. 29
2.4.3.2. How do we measure this?.............................................................................30
2.4.3.3. What are the results?....................................................................................34
2.5. Conclusion...................................................................................................................... 35
2.5.1. Examples............................................................................................................... 36
2.5.2. Key take-aways......................................................................................................36
Chapter 3: Positioning investment products.......................................................................... 37
3.1. Return distributions.........................................................................................................37
3.1.1. Simulations:........................................................................................................... 37
3.1.2. Return distributions: time-series view.................................................................... 38
3.1.2. Return distributions: Cross-sectional view............................................................. 38
3.2. Mean and variance (random walks)................................................................................38
3.2.1. A specific discrete time random walk:....................................................................38
3.2.2. The standardnormal distribution: ε~N(0,1).............................................................39
3.2.3. The normal distribution: Δx=μΔt+εσ√Δt with ε~N(0,1)........................................... 40
3.2.4. Simulation of future stock prices............................................................................ 40
3.2.5. Random walks in stock market prices, Fama (1965)............................................. 41
3.2.6. Can machines “learn” finance?, Israel et al. (2020)............................................... 42
3.3. Upside potential and downside risk (skewness has a price).......................................... 43
3.3.1. Product classification based on mean and variance..............................................44
3.3.2. Skewness...............................................................................................................45
3.3.2.1. Skewness & Prospect theory........................................................................ 45
3.3.2.2. Skewness & risk perception..........................................................................45
3.3.3. Product classification based on (potential) asymmetry..........................................46
3.3.3.1. Upside potential (U) and downside risk (D).................................................. 46
3.4. Understanding the various aspects of a product offer.................................................... 48
3.4.1. Product classification............................................................................................. 48
3.4.1.1. Product classification – example of how to complete the offer..................... 48
3.5. Applied to performance reporting................................................................................... 49
3.6. Use case: structured products........................................................................................ 50
3.6.1. Base case: term deposit........................................................................................ 50
3.6.2. Variation: structured fund....................................................................................... 51
3.6.3. Variation: defaultable bond.................................................................................... 51
1
, 3.6.4. Variation: structured bond...................................................................................... 51
3.6.5. The « fundamental law » of structured products....................................................51
3.6.6. Structured funds vs structured bonds.................................................................... 52
3.6.6.1. Example of a structured fund........................................................................ 52
3.6.6.2. Example of a structured bond /note.............................................................. 53
3.6.7. Fees in structured products................................................................................... 53
3.6.8. Options...................................................................................................................54
3.6.8.1. Buying a call option.......................................................................................54
3.6.8. Make your own structured product.........................................................................54
Chapter 4: Constructing investment portfolios...................................................................... 58
4.1. Classic portfolio theory (the power of diversification, efficient portfolios)....................... 58
4.1.1. The power of diversification................................................................................... 58
4.1.1.1 The power of diversification: two assets........................................................ 59
4.1.1.2. The power of diversification: three assets.....................................................61
4.1.2. Classic approaches:...............................................................................................61
4.1.3. Goals based wealth management......................................................................... 62
4.2. Behavioral portfolio theory (adaptivity, probability matching)..........................................63
4.2.1. Adaptivity 1............................................................................................................ 63
4.2.1.1. Start by setting goals.................................................................................... 64
4.2.1.2. Next adapt by switching between efficient allocations while staying on course
for goal achievement..................................................................................................65
4.2.2. Adaptivity 2............................................................................................................ 65
4.2.2.1. Focus on step 3: finding optimal strategy weights........................................ 67
4.2.2.2. Probability matching: explained.................................................................... 67
4.3. Behavioral portfolio theory (finance for normal people).................................................. 68
4.4. Use case: comfort zone investing...................................................................................68
4.4.1. explore – experiment - experience.........................................................................69
2
, Chapter 1: Digital household finance - positioning
1.1. CIF: Corporate finance & household finance
Emotional component of investing → greatest challenge in investing → people are not rational
→ How do households use financial instruments to attain their objectives?
→ Households are not RATIONAL
Known examples of mistakes in household finance:
● Underparticipation in financial markets: households do not invest enough
● Underdiversification in portfolios: when they invest, households hold too few assets (no ETF’s)
● Underusage of annuities: households prefer lump sum pensions over monthly “for life’
How to fix these mistakes?
● Build models that improve our understanding of actual behavior
○ BUT this explains the initial differences but does this mean they disappeared?
○ There might still be a welfare cost attached to the actual behavior
● Two ways of reflecting
○ Financial education: team people how to do better (doesn’t work always)
○ Financial engineering: change context, improve products so people do better
⇒ First improve our understanding of human behaviour, next use this knowledge to build applications
that improve financial wellbeing in a digital world.
1.2. Recent European initiatives to improve financial wellbeing at
societal level
1.2.1. Belgian example: Pensiontest
Key features: showing the difference / preference between lump sum pension or annuities. → and show
the risk for each option.
1.2.2. Financial literacy
EU Commission survey on Financial literacy and financial self awareness 2023
→ Questions asked:
● If interest rates rise, what typically happens to bond prices?
● An investment with higher return rate is likely to be…?
● An investment in a wide range of company shares is likely to be…?
● I set long term financial goals and thrive to achieve them. Agree or disagree?
● Which of these financial products do you currently have: share(s), ETF(s), crypto?
3
FINANCE 2025 - PART 2
Chapter 1: Digital household finance - positioning...................................................................................3
1.1. CIF: Corporate finance & household finance...................................................................................3
1.2. Recent European initiatives to improve financial wellbeing at societal level.................... 3
1.2.1. Belgian example: Pensiontest..................................................................................3
1.2.2. Financial literacy..................................................................................................... 3
1.2.3. Financial Resilience................................................................................................. 4
1.2.3.1. Europe’s “Retail Investment Strategy”............................................................ 4
1.2.3.2. Europe’s “Savings and Investments Union”.................................................... 5
1.2.3.3. Regulatory and supervisory initiatives............................................................ 5
1.3. Motivation to focus on (digital) investing...........................................................................7
1.3.1. 3 recent analyses.....................................................................................................7
1.3.1.1. How technology has the potential to increase financial welfare......................7
1.3.1.2. How technology has the potential to boost financial inclusion...................... 10
1.3.1.3. How technology may also challenge financial welfare..................................10
1.3.2. The rise of the retail investor..................................................................................13
1.3.2.1. FSMA Retail investor Dashboard..................................................................14
1.3.2.2. Efficient of financial markets (Eugene Fama).............................................. 15
1.3.2.3. The inefficiency of markets........................................................................... 16
1.3.2.4. The inelastic market hypothesis....................................................................16
1.3.3. The emotional component of investing.................................................................. 17
1.3.3.1. Digital conversion..........................................................................................17
1.3.4. The behavioral design of financial services........................................................... 18
1.3.4.1. Nudging - choice architecture....................................................................... 19
1.3.4.2. Behavioral design for digital financial services............................................. 19
1.4. Behaviour finance and the enhancement of traditional finance...................................... 21
Chapter 2: Digital household finance - People: Profiling investors..................................... 22
2.1. Expected value (Sint-Petersburg paradox).....................................................................22
2.2. Expected utility (rules of rationality)................................................................................ 23
2.2.1. Development of the Expected Utility Framework................................................... 23
2.2.2. Challenges for the Expected Utility Framework..................................................... 24
2.2.2.1. Consistent and predictable violation of the “rules of rationality”....................24
2.2.2.2. “Your actions reveal your preferences.” BUT: The case of organ donation..24
2.2.2.3. “People don’t choose between things but between the representation of
things.”....................................................................................................................... 24
2.2.3. Relevance in the context of household finance..................................................... 25
2.3. Prospect utility (reference point, loss aversion, probability weighting)........................... 25
, 2.3.1. Prospect Utility – probability weighting.................................................................. 25
2.3.2. Prospect Utility – functional form........................................................................... 26
2.4. Use case: investor risk profiling...................................................................................... 26
2.4.1. Improve in content................................................................................................. 27
2.4.1.1. Book: Thinking Fast and slow....................................................................... 28
2.4.2. Improve in Method................................................................................................. 28
2.4.3. International Research On “Financial Personalities”..............................................29
2.4.3.1. What did we measure?................................................................................. 29
2.4.3.2. How do we measure this?.............................................................................30
2.4.3.3. What are the results?....................................................................................34
2.5. Conclusion...................................................................................................................... 35
2.5.1. Examples............................................................................................................... 36
2.5.2. Key take-aways......................................................................................................36
Chapter 3: Positioning investment products.......................................................................... 37
3.1. Return distributions.........................................................................................................37
3.1.1. Simulations:........................................................................................................... 37
3.1.2. Return distributions: time-series view.................................................................... 38
3.1.2. Return distributions: Cross-sectional view............................................................. 38
3.2. Mean and variance (random walks)................................................................................38
3.2.1. A specific discrete time random walk:....................................................................38
3.2.2. The standardnormal distribution: ε~N(0,1).............................................................39
3.2.3. The normal distribution: Δx=μΔt+εσ√Δt with ε~N(0,1)........................................... 40
3.2.4. Simulation of future stock prices............................................................................ 40
3.2.5. Random walks in stock market prices, Fama (1965)............................................. 41
3.2.6. Can machines “learn” finance?, Israel et al. (2020)............................................... 42
3.3. Upside potential and downside risk (skewness has a price).......................................... 43
3.3.1. Product classification based on mean and variance..............................................44
3.3.2. Skewness...............................................................................................................45
3.3.2.1. Skewness & Prospect theory........................................................................ 45
3.3.2.2. Skewness & risk perception..........................................................................45
3.3.3. Product classification based on (potential) asymmetry..........................................46
3.3.3.1. Upside potential (U) and downside risk (D).................................................. 46
3.4. Understanding the various aspects of a product offer.................................................... 48
3.4.1. Product classification............................................................................................. 48
3.4.1.1. Product classification – example of how to complete the offer..................... 48
3.5. Applied to performance reporting................................................................................... 49
3.6. Use case: structured products........................................................................................ 50
3.6.1. Base case: term deposit........................................................................................ 50
3.6.2. Variation: structured fund....................................................................................... 51
3.6.3. Variation: defaultable bond.................................................................................... 51
1
, 3.6.4. Variation: structured bond...................................................................................... 51
3.6.5. The « fundamental law » of structured products....................................................51
3.6.6. Structured funds vs structured bonds.................................................................... 52
3.6.6.1. Example of a structured fund........................................................................ 52
3.6.6.2. Example of a structured bond /note.............................................................. 53
3.6.7. Fees in structured products................................................................................... 53
3.6.8. Options...................................................................................................................54
3.6.8.1. Buying a call option.......................................................................................54
3.6.8. Make your own structured product.........................................................................54
Chapter 4: Constructing investment portfolios...................................................................... 58
4.1. Classic portfolio theory (the power of diversification, efficient portfolios)....................... 58
4.1.1. The power of diversification................................................................................... 58
4.1.1.1 The power of diversification: two assets........................................................ 59
4.1.1.2. The power of diversification: three assets.....................................................61
4.1.2. Classic approaches:...............................................................................................61
4.1.3. Goals based wealth management......................................................................... 62
4.2. Behavioral portfolio theory (adaptivity, probability matching)..........................................63
4.2.1. Adaptivity 1............................................................................................................ 63
4.2.1.1. Start by setting goals.................................................................................... 64
4.2.1.2. Next adapt by switching between efficient allocations while staying on course
for goal achievement..................................................................................................65
4.2.2. Adaptivity 2............................................................................................................ 65
4.2.2.1. Focus on step 3: finding optimal strategy weights........................................ 67
4.2.2.2. Probability matching: explained.................................................................... 67
4.3. Behavioral portfolio theory (finance for normal people).................................................. 68
4.4. Use case: comfort zone investing...................................................................................68
4.4.1. explore – experiment - experience.........................................................................69
2
, Chapter 1: Digital household finance - positioning
1.1. CIF: Corporate finance & household finance
Emotional component of investing → greatest challenge in investing → people are not rational
→ How do households use financial instruments to attain their objectives?
→ Households are not RATIONAL
Known examples of mistakes in household finance:
● Underparticipation in financial markets: households do not invest enough
● Underdiversification in portfolios: when they invest, households hold too few assets (no ETF’s)
● Underusage of annuities: households prefer lump sum pensions over monthly “for life’
How to fix these mistakes?
● Build models that improve our understanding of actual behavior
○ BUT this explains the initial differences but does this mean they disappeared?
○ There might still be a welfare cost attached to the actual behavior
● Two ways of reflecting
○ Financial education: team people how to do better (doesn’t work always)
○ Financial engineering: change context, improve products so people do better
⇒ First improve our understanding of human behaviour, next use this knowledge to build applications
that improve financial wellbeing in a digital world.
1.2. Recent European initiatives to improve financial wellbeing at
societal level
1.2.1. Belgian example: Pensiontest
Key features: showing the difference / preference between lump sum pension or annuities. → and show
the risk for each option.
1.2.2. Financial literacy
EU Commission survey on Financial literacy and financial self awareness 2023
→ Questions asked:
● If interest rates rise, what typically happens to bond prices?
● An investment with higher return rate is likely to be…?
● An investment in a wide range of company shares is likely to be…?
● I set long term financial goals and thrive to achieve them. Agree or disagree?
● Which of these financial products do you currently have: share(s), ETF(s), crypto?
3
