Approximated Portfolio Choice - Do We Dance on a Pinhead?

32 Pages Posted: 16 Feb 2009

See all articles by Ferdinand Graf

Ferdinand Graf

University of Konstanz

Guenter Franke

University of Konstanz - Department of Economics

Date Written: February 13, 2009

Abstract

HARA-utility investors allocate their money to a risk-free fund and to a risky fund (two fund separation). The paper shows that under weak conditions, the risky fund can be approximated by the risky fund derived from exponential utility, without material effects on the certainty equivalent of the portfolio payoff. Also, effects of changes in asset return parameters on the risky fund can be approximated using the exponential utility function, thereby simplifying the analysis. The approximation is of high quality if extreme portfolio returns have a very small probability and if the investor's level of relative risk aversion exceeds 2.

Keywords: HARA-utility, portfolio choice, certainty equivalent, approximated choice

JEL Classification: G10, G11, D81

Suggested Citation

Graf, Ferdinand and Franke, Guenter, Approximated Portfolio Choice - Do We Dance on a Pinhead? (February 13, 2009). Available at SSRN: https://ssrn.com/abstract=1342589 or http://dx.doi.org/10.2139/ssrn.1342589

Ferdinand Graf

University of Konstanz ( email )

Fach D-144
Konstanz, D-78457
Germany

Guenter Franke (Contact Author)

University of Konstanz - Department of Economics ( email )

Fach 147
Konstanz, 78457
Germany
+49 7531 88 2545 (Phone)
+49 7531 88 3559 (Fax)

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