Article ID: | iaor20111425 |
Volume: | 70 |
Issue: | 2 |
Start Page Number: | 149 |
End Page Number: | 155 |
Publication Date: | Feb 2011 |
Journal: | Theory and Decision |
Authors: | Johnstone J, Lindley V |
Keywords: | utility |
An extensive literature overlapping economics, statistical decision theory and finance, contrasts expected utility [EU] with the more recent framework of mean–variance (MV). A basic proposition is that MV follows from EU under the assumption of quadratic utility. A less recognized proposition, first raised by Markowitz, is that MV is fully justified under EU, if and only if utility is quadratic. The existing proof of this proposition relies on an assumption from EU, described here as ‘Buridan's axiom’ after the French philosopher's fable of the ass that starved out of indifference between two bales of hay. To satisfy this axiom, MV must represent not only ‘pure’ strategies, but also their probability mixtures, as points in the (