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Rationalization of Investment Preference Criteria

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  • Jacques Pézier

    (ICMA Centre, Henley Business School,University of Reading)

Abstract

The majority of risk adjusted performance measures (RAPM) currently in use - e.g., Treynor ratio, (α/β)) ratio, Omega index, RoVaR, 'coherent' preference criteria, etc. - are incompat- ible with any sensible utility function and would be best avoided. We argue instead for the assessment of a maximum certainty equivalent excess return (CER*) criterion, or equivalent criteria, adapted to investment circumstances: alternative investments, return forecasts, and risk attitude. We explain the assessment of CER*s and give three applications: performance comparisons among traditional and alternative funds, optimal design of structured products, and explanation of the credit risk premium puzzle.

Suggested Citation

  • Jacques Pézier, 2011. "Rationalization of Investment Preference Criteria," ICMA Centre Discussion Papers in Finance icma-dp2011-12, Henley Business School, University of Reading.
    • Handle: RePEc:rdg:icmadp:icma-dp2011-12
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    File URL: http://www.icmacentre.ac.uk/files/discussion-papers/DP2011-12.pdf
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    More about this item

    Keywords

    Certainty equivalent return; risk-adjusted performance measure; risk aversion; HARA utility functions; coherent risk measures; spectral indices; Sharpe ratio; generalized Sharpe ratio; information ratio; Treynor ratio; Jensen alpha; skewness; kurtosis; volatility skew; optimal structured products; credit risk premium.;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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