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Bliss Points in Mean-Variance Portfolio Models

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  • David S. Jones
  • V. Vance Roley
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    Abstract

    When all financial assets have risky returns, the mean-variance portfolio model is potentially subject to two types of bliss points. One bliss point arises when a von Neumann-Morgenstern utility function displays negative marginal utility for sufficiently large end-of-period wealth, such as in quadratic utility. The second type of bliss point involves satiation in terms of beginning-of-period wealth and afflicts many commonly used mean-variance preference functions. This paper shows that the two types of bliss points are logically independent of one another and that the latter places the effective constraint on an investor's welfare. The paper also uses Samuelson's Fundamental Approximation Theorem to motivate a particular mean-variance portfolio choice model which is not affected by either type of bliss point.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Technical Working Papers with number 0019.

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    Date of creation: Dec 1981
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    Handle: RePEc:nbr:nberte:0019

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    1. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, Econometric Society, vol. 41(5), pages 867-87, September.
    2. Samuelson, Paul A, 1970. "The Fundamental Approximation Theorem of Portfolio Analysis in terms of Means, Variances, and Higher Moments," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 37(4), pages 537-42, October.
    3. Levy, Haim, 1974. "The Rationale of the Mean-Standard Deviation Analysis: Comment," American Economic Review, American Economic Association, American Economic Association, vol. 64(3), pages 434-41, June.
    4. Merton, Robert C., 1972. "An Analytic Derivation of the Efficient Portfolio Frontier," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 7(04), pages 1851-1872, September.
    5. Borch, Karl, 1974. "The Rationale of the Mean-Standard Deviation Analysis: Comment," American Economic Review, American Economic Association, American Economic Association, vol. 64(3), pages 428-30, June.
    6. Samuelson, Paul A., 1967. "General Proof that Diversification Pays," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 2(01), pages 1-13, March.
    7. Friend, Irwin & Landskroner, Yoram & Losq, Etienne, 1976. "The Demand for Risky Assets under Uncertain Inflation," Journal of Finance, American Finance Association, American Finance Association, vol. 31(5), pages 1287-97, December.
    8. Tsiang, S C, 1972. "The Rationale of the Mean-Standard Deviation Analysis, Skewness Preference, and the Demand for Money," American Economic Review, American Economic Association, American Economic Association, vol. 62(3), pages 354-71, June.
    9. Borch, Karl, 1969. "A Note on Uncertainty and Indifference Curves," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 36(105), pages 1-4, January.
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    18. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, Elsevier, vol. 3(4), pages 373-413, December.
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    20. Friend, Irwin & Blume, Marshall E, 1975. "The Demand for Risky Assets," American Economic Review, American Economic Association, American Economic Association, vol. 65(5), pages 900-922, December.
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    Cited by:
    1. Benjamin M. Friedman & V. Vance Roley, 1985. "Aspects of Investor Behavior Under Risk," NBER Working Papers 1611, National Bureau of Economic Research, Inc.

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