Article ID: | iaor1995605 |
Country: | Netherlands |
Volume: | 17 |
Issue: | 5/6 |
Start Page Number: | 887 |
End Page Number: | 906 |
Publication Date: | Sep 1993 |
Journal: | Journal of Economic Dynamics and Control |
Authors: | Luenberger David G. |
Keywords: | portfolio analysis |
The appropriate criterion for evaluating, and hence also for properly constructing, investment portfolios whose performance is governed by an infinite sequence of stochastic returns has long been a subject of controversy and fascination. A criterion based on the expected logarithm of one-period return is known to lead to exponential growth with the greatest exponent, almost surely; and hence this criterion is frequently proposed. A refinement has been to include the variance of the logarithm of return as well, but this has had no substantial theoretical justification. This paper shows that log mean-variance criteria follow naturally from elementary assumptions on an individual's preference relation for deterministic wealth sequences. As a first and fundamental step, it is shown that if a preference relation involves only the tail of a sequence, then that relation can be extended to stochastic wealth sequences by almost sure equality. It is not necessary to introduce a von Neumann-Morgenstern utility function or the associated axioms. It is then shown that if tail preferences can be described by a ‘simple’ utility function, one that is of the form