This file is part of IDEAS, which uses RePEc data


[ Papers | Articles | Software | Books | Chapters | Authors | Institutions | JEL Classification | NEP reports | Search | New papers by email | Author registration | Rankings | Volunteers | FAQ | Blog | Help! ]

Optimal Portfolio Allocation Under Higher Moments

Author info | Abstract | Publisher info | Download info | Related research | Statistics
Author Info
Jondeau, E.
Rockinger, M.
Abstract

We evaluate how departure from normality may affect the allocation of assets. A Taylor series expansion of the expected utility allows to focus on certain moments and to compute numerically the optimal portfolio allocation. A decisive advantage of this approach is that it remains operational even if a large number of assets is involved. We show that under moderate non-normality the mean-variance criterion provides a good approximation of the expected utility maximization. In contrast, under large departure from normality (as found in some stocks in mature markets or in some stock indices in emerging markets), the mean-variance criterion may fail to approximate the expected utility correctly. In such cases, the three-moment or four-moment optimization strategies may provide a good approximation of the expected utility.

Download Info
To download:

If you experience problems downloading a file, check if you have the proper application to view it first. Information about this may be contained in the File-Format links below. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.banque-france.fr/gb/publications/telechar/ner/ner108.pdf
File Format: application/pdf
File Function:
Download Restriction: no

Publisher Info
Paper provided by Banque de France in its series Documents de Travail with number 108.

Download reference. The following formats are available: HTML (with abstract), plain text (with abstract), BibTeX, RIS (EndNote, RefMan, ProCite), ReDIF
Length: 39 pages
Date of creation: 2004
Date of revision:
Handle: RePEc:bfr:banfra:108

Contact details of provider:
Postal: Banque de France 31 Rue Croix des Petits Champs LABOLOG - 49-1404 75049 PARIS
Web page: http://www.banque-france.fr/
More information through EDIRC

For technical questions regarding this item, or to correct its listing, contact: (Thierry Demoulin).

Related research
Keywords: Asset allocation ; Stock returns ; Non-normality ; Utility function;

Find related papers by JEL classification:
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions
C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Robert F. Dittmar, 2002. "Nonlinear Pricing Kernels, Kurtosis Preference, and Evidence from the Cross Section of Equity Returns," Journal of Finance, American Finance Association, vol. 57(1), pages 369-403, 02. [Downloadable!] (restricted)
  2. Sun, Qian & Yan, Yuxing, 2003. "Skewness persistence with optimal portfolio selection," Journal of Banking & Finance, Elsevier, vol. 27(6), pages 1111-1121, June. [Downloadable!] (restricted)
  3. Singleton, J. Clay & Wingender, John, 1986. "Skewness Persistence in Common Stock Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(03), pages 335-341, September. [Downloadable!]
  4. Harvey, Campbell R, 1995. "Predictable Risk and Returns in Emerging Markets," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 8(3), pages 773-816. [Downloadable!] (restricted)
    Other versions:
  5. 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.
  6. Ait-Sahalia, Y. & Brandt, M.W., 2001. "Variable Selection for Portfolio Choice," Papers 34, Manitoba - Department of Economics.
    Other versions:
  7. Jean, William H., 1971. "The Extension of Portfolio Analysis to Three or More Parameters," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 6(01), pages 505-515, January. [Downloadable!]
  8. Geert Bekaert & Campbell R. Harvey, 1997. "Emerging Equity Market Volatility," NBER Working Papers 5307, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  9. Hlawitschka, Walter, 1994. "The Empirical Nature of Taylor-Series Approximations to Expected Utility," American Economic Review, American Economic Association, vol. 84(3), pages 713-19, June. [Downloadable!] (restricted)
  10. Sears, R Stephen & Wei, K C John, 1985. " Asset Pricing, Higher Moments, and the Market Risk Premium: A Note," Journal of Finance, American Finance Association, vol. 40(4), pages 1251-53, September. [Downloadable!] (restricted)
  11. Chunhachinda, Pornchai & Dandapani, Krishnan & Hamid, Shahid & Prakash, Arun J., 1997. "Portfolio selection and skewness: Evidence from international stock markets," Journal of Banking & Finance, Elsevier, vol. 21(2), pages 143-167, February. [Downloadable!] (restricted)
  12. Hwang, Soosung & Satchell, Stephen E, 1999. "Modelling Emerging Market Risk Premia Using Higher Moments," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 4(4), pages 271-96, October. [Downloadable!] (restricted)
  13. Jarque, Carlos M. & Bera, Anil K., 1980. "Efficient tests for normality, homoscedasticity and serial independence of regression residuals," Economics Letters, Elsevier, vol. 6(3), pages 255-259. [Downloadable!] (restricted)
  14. Raymond Kan & Guofu Zhou, 1999. "A Critique of the Stochastic Discount Factor Methodology," Journal of Finance, American Finance Association, vol. 54(4), pages 1221-1248, 08. [Downloadable!] (restricted)
  15. Campbell R. Harvey & Akhtar Siddique, 2000. "Conditional Skewness in Asset Pricing Tests," Journal of Finance, American Finance Association, vol. 55(3), pages 1263-1295, 06. [Downloadable!] (restricted)
  16. Arditti, Fred D, 1969. "A Utility Function Depending on the First Three Moments: Reply," Journal of Finance, American Finance Association, vol. 24(4), pages 720, September.
  17. John Y. Campbell & Luis M. Viceira, 1999. "Consumption And Portfolio Decisions When Expected Returns Are Time Varying," The Quarterly Journal of Economics, MIT Press, vol. 114(2), pages 433-495, May. [Downloadable!] (restricted)
    Other versions:
  18. Hansen, Bruce E, 1994. "Autoregressive Conditional Density Estimation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 35(3), pages 705-30, August. [Downloadable!] (restricted)
    Other versions:
  19. Pulley, Lawrence B., 1981. "A General Mean-Variance Approximation to Expected Utility for Short Holding Periods," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 16(03), pages 361-373, September. [Downloadable!]
  20. Harvey, Campbell R. & Siddique, Akhtar, 1999. "Autoregressive Conditional Skewness," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 34(04), pages 465-487, December. [Downloadable!]
  21. Benoit Mandelbrot, 1963. "The Variation of Certain Speculative Prices," Journal of Business, University of Chicago Press, vol. 36, pages 394. [Downloadable!]
  22. Kraus, Alan & Litzenberger, Robert H, 1976. "Skewness Preference and the Valuation of Risk Assets," Journal of Finance, American Finance Association, vol. 31(4), pages 1085-1100, September. [Downloadable!] (restricted)
  23. Barone-Adesi, Giovanni, 1985. "Arbitrage Equilibrium with Skewed Asset Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(03), pages 299-313, September. [Downloadable!]
  24. Rubinstein, Mark E., 1973. "The Fundamental Theorem of Parameter-Preference Security Valuation," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 8(01), pages 61-69, January. [Downloadable!]
  25. Luc Bauwens & Sébastien Laurent, 2002. "A New Class of Multivariate skew Densities, with Application to GARCH Models," Computing in Economics and Finance 2002 5, Society for Computational Economics.
    Other versions:
  26. Hanoch, Giora & Levy, Haim, 1970. "Efficient Portfolio Selection with Quadratic and Cubic Utility," Journal of Business, University of Chicago Press, vol. 43(2), pages 181-89, April. [Downloadable!] (restricted)
  27. Scott, Robert C & Horvath, Philip A, 1980. " On the Direction of Preference for Moments of Higher Order Than the Variance," Journal of Finance, American Finance Association, vol. 35(4), pages 915-19, September. [Downloadable!] (restricted)
  28. Peiro, Amado, 1999. "Skewness in financial returns," Journal of Banking & Finance, Elsevier, vol. 23(6), pages 847-862, June. [Downloadable!] (restricted)
  29. Andrew Ang & Geert Bekaert, 2002. "International Asset Allocation With Regime Shifts," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 15(4), pages 1137-1187.
  30. Longin, Francois M, 1996. "The Asymptotic Distribution of Extreme Stock Market Returns," Journal of Business, University of Chicago Press, vol. 69(3), pages 383-408, July. [Downloadable!] (restricted)
  31. Ramchand, Latha & Susmel, Raul, 1998. "Volatility and cross correlation across major stock markets," Journal of Empirical Finance, Elsevier, vol. 5(4), pages 397-416, October. [Downloadable!] (restricted)
  32. Sears, R Stephen & Wei, K C John, 1988. "The Structure of Skewness Preferences in Asset Pricing Models with Higher Moments: An Empirical Test," The Financial Review, Eastern Finance Association, vol. 23(1), pages 25-38, February.
  33. Blattberg, Robert C & Gonedes, Nicholas J, 1974. "A Comparison of the Stable and Student Distributions as Statistical Models for Stock Prices," Journal of Business, University of Chicago Press, vol. 47(2), pages 244-80, April. [Downloadable!] (restricted)
  34. Kroll, Yoram & Levy, Haim & Markowitz, Harry M, 1984. " Mean-Variance versus Direct Utility Maximization," Journal of Finance, American Finance Association, vol. 39(1), pages 47-61, March. [Downloadable!] (restricted)
  35. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-96, March. [Downloadable!] (restricted)
  36. Simkowitz, Michael A. & Beedles, William L., 1978. "Diversification in a Three-Moment World," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 13(05), pages 927-941, December. [Downloadable!]
  37. Stephen Satchell & Soosung Hwang, 1999. "Modelling Emerging Market Risk Premia Using Higher Moments," Working Papers wp99-17, Warwick Business School, Financial Econometrics Research Centre. [Downloadable!]
  38. Eugene F. Fama, 1963. "Mandelbrot and the Stable Paretian Hypothesis," Journal of Business, University of Chicago Press, vol. 36, pages 420. [Downloadable!]
Full references

Statistics
Access and download statistics

Did you know? Citation analysis on IDEAS includes online papers that are freely accessible and whose text could be automatically analyzed, currently about 210000 papers.

This page was last updated on 2009-11-24.

This information is provided to you by IDEAS at the Department of Economics, College of Liberal Arts and Sciences, University of Connecticut using RePEc data on a server sponsored by the Society for Economic Dynamics.