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Professional money managers often combine value and momentum to benefit from diversification gains resulting from their negative return correlation. We go beyond the mean-variance and constant relative risk aversion environments to investigate this fundamental issue by assuming that investors exhibit disappointment aversion, and empirically account for the non-normalities and non-linear dependencies of the returns associated with these strategies. We perform an exploration exercise on the interplay of these two general sets of assumptions. In accordance with the literature, we find that disappointment preferences lead to optimal portfolio choices that are not attainable under the traditional constant relative risk aversion case. The findings reveal that higher disappointment aversion utility levels can be reached when non-normalities are introduced in the optimization process. The intensity of this phenomenon rises as disappointment aversion increases. However, taking advantage of these non-linearities and non-normalities requires higher portfolio turnovers. Therefore, when introducing transaction costs in the analysis, we find significant improvement in certainty equivalent returns only for investors having high disappointment aversion levels and facing low transaction costs. [ABSTRACT FROM AUTHOR]

Rubinstein developed a binomial lattice technique for pricing European and American derivatives in the context of skewed and leptokurtic asset return distributions. A drawback of this approach is the limited set of skewness and kurtosis pairs for which valid stock return distributions are possible. A solution to this problem is proposed here by extending Rubinstein's Edgeworth tree idea to the case of the Johnson system of distributions which is capable of accommodating all possible skewness and kurtosis pairs. Numerical examples showing the performance of the Johnson tree to approximate the prices of European and American options in Merton's jump diffusion framework and Duan's GARCH framework are examined. [ABSTRACT FROM AUTHOR]