2MEAN-VARIANCE APPROXIMATIONS TO EXPECTED UTILITY

INTRODUCTION

In the preceding chapter, we explained why we accept the expected utility rule as the standard for rational choice among probability distributions. We also explained that in the case of probability distributions of portfolio returns, concave-shaped utility functions lead to risk-avoiding choices: given the choice between a particular return R with certainty versus a random outcome with R as its expected value, the decision maker who maximizes the expected value of a strictly concave utility function will prefer the certain to the random outcome. In this chapter and the next, we explore whether some function of mean and variance can provide a good approximation to the expected values ...

Get Risk-Return Analysis: The Theory and Practice of Rational Investing (Volume One) now with the O’Reilly learning platform.

O’Reilly members experience books, live events, courses curated by job role, and more from O’Reilly and nearly 200 top publishers.