A new foundation for the mean–variance analysis

A new foundation for the mean–variance analysis

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Article ID: iaor20052632
Country: Netherlands
Volume: 158
Issue: 1
Start Page Number: 229
End Page Number: 242
Publication Date: Oct 2004
Journal: European Journal of Operational Research
Authors:
Keywords: statistics: general
Abstract:

In this paper, I re-examine how the mean–variance analysis is consistent with its traditional theoretical foundations, namely, stochastic dominance and the expected utility theory. Then I propose a simplified version of the coarse utility theory as a new foundation. I prove that, by assuming risk aversion and the normality of asset variables, the simplified model is well behaved; indifference curves are convex and the opportunity set is concave. Therefore, there exist global optimal portfolios in the market. Finally, I prove that decision-making in accordance with the simplified model is consistent with the mean–variance analysis.

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