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Exponential risk measure with application to UK asset allocation

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  • Stephen Satchell
  • David Damant
  • Soosung Hwang

Abstract

In the paper the exponential risk measure of Damant and Satchell is used to formulate an investor's utility function and the properties of this function are investigated. The utility function is calibrated for a typical UK investor who would hold different proportions of equity. It is found that, for plausible parameter values, a typical UK investor will hold more equity under the assumption of non-normality of return if his utility function has the above formulation and not the standard mean-variance utility function. Furthermore, our utility function is consistent with positive skewness affection and kurtosis aversion. Some aggregate estimates of risk parameters are calculated for the typical UK investor. These do not seem well determined, raising issues of the roles of aggregation and wealth in this model.

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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal Applied Mathematical Finance.

Volume (Year): 7 (2000)
Issue (Month): 2 ()
Pages: 127-152

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Handle: RePEc:taf:apmtfi:v:7:y:2000:i:2:p:127-152

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Related research

Keywords: Exponential Risk Measure Utility Function Skewness Kurtosis Capm Downside Risk Asset Allocation;

References

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  1. Knight, J.L. & Stachell, S.E. & Tran, K.C., 1995. "Statistical Modeling of Asymetric Risk in Asset Returns," Papers 95-3, Saskatchewan - Department of Economics.
  2. Robert R. Grauer & Nils H. Hakansson, 1995. "Gains From Diversifying Into Real Estate: Three Decades of Portfolio Returns Based on the Dynamic Investment Model," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 23(2), pages 117-159.
  3. Fishburn, Peter C, 1977. "Mean-Risk Analysis with Risk Associated with Below-Target Returns," American Economic Review, American Economic Association, vol. 67(2), pages 116-26, March.
  4. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
  5. Hansen, Lars Peter & Singleton, Kenneth J, 1982. "Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 50(5), pages 1269-86, September.
  6. Levy, H & Markowtiz, H M, 1979. "Approximating Expected Utility by a Function of Mean and Variance," American Economic Review, American Economic Association, vol. 69(3), pages 308-17, June.
  7. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56, pages 279.
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