Chapter 6

Risk Aversion and Investment Decisions, Part II

Modern Portfolio Theory

Chapter 6 introduces Modern Portfolio Theory (MPT). This theory explores the details of portfolio choice (i) under the mean-variance utility hypothesis, and (ii) for an arbitrary number of risky investment possibilities, with or without the availability of a risk-free asset. Its objective is to introduce the notion of the “gains to diversification”; that is, the higher expected portfolio returns and/or lower portfolio risk that can be realized when an investor’s wealth is invested in many different assets. The connection between the mean-variance utility hypothesis employed in this chapter and the earlier VNM expected utility discussion is provided.


Normality-of-returns; ...

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