Choosing and Using Utility Functions in Forming Portfolios. Issue 3 (1st July 2019)

• Record Type: Journal Article
• Authors: Warren, Geoffrey J.
• Is Part Of: Financial analysts journal. Volume 75:Issue 3(2019)
• Page Start: 39
• Page End: 69
• Publication Date: 2019-07-01
• Subjects: Investment analysis -- Periodicals; Investment analysis; HW_FM; Periodicals; Electronic journals; 332.6
• DOI: 10.1080/0015198X.2019.1618109
• Languages: English
• ISSNs: 0015-198X

Abstract

Abstract : Utility functions offer a means to encode objectives and preferences in investor portfolios. The functions allow one to place a score on outcomes and then identify optimal portfolios by maximizing utility. The central theme of this article is that utility functions should be tailored to the investor. I discuss how an appropriate function might be chosen and demonstrate concepts for power utility and reference-dependent utility. A modeling approach is presented that may be applied without resorting to dynamic optimization. The selection of utility functions is illustrated for four investor types. Abstract : Disclosure: The author reports no conflict of interest. Editor's Note The original version had a typographical error in Figure 4B, which has been corrected in this version. Submitted 1 October 2018 Accepted 20 March 2019 by Stephen J. Brown