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Optimal Asset Allocation Based on Utility Maximization in the Presence of Market Frictions

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  • Alessandro Bucciol
  • Raffaele Miniaci

Abstract

We develop a model of optimal asset allocation based on a utility framework. This applies to a more general context than the classical mean-variance paradigm since it can also account for the presence of constraints in the portfolio composition. Using this approach, we study the distribution of a measure of wealth compensative variation, we propose a benchmark and portfolio efficiency test and a procedure to estimate the implicit risk aversion parameter of a power utility function. Our empirical analysis makes use of the S&P 500 and industry portfolios time series to show that although the market index cannot be considered an efficient investment in the mean-variance metric, the wealth loss associated with such an investment is statistically different from zero but rather small (lower than 0.5%). The wealth loss is at its minimum for a representative agent with a constant risk aversion index not higher than 5. Furthermore we show that, for reasonable levels of risk aversion, the use of an equally weighted portfolio is surprisingly consistent with an expected utility maximizing behavior.

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Bibliographic Info

Paper provided by University of Brescia, Department of Economics in its series Working Papers with number ubs0605.

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Date of creation: 2006
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Handle: RePEc:ubs:wpaper:ubs0605

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  1. Dybvig, Philip H, 1984. " Short Sales Restrictions and Kinks on the Mean Variance Frontier," Journal of Finance, American Finance Association, vol. 39(1), pages 239-44, March.
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Citations

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Cited by:
  1. Amedeo Fossati & Rosella Levaggi, 2008. "Delay is not the answer: waiting time in health care & income redistribution," Working Papers 0801, University of Brescia, Department of Economics.
  2. Alessandro Fedele & Raffaele Miniaci, 2010. "Do Social Enterprises Finance Their Investments Differently from For-profit Firms? The Case of Social Residential Services in Italy," Journal of Social Entrepreneurship, Taylor & Francis Journals, vol. 1(2), pages 174-189, October.
  3. Alessandra Del Boca & Michele Fratianni & Franco Spinelli & Carmine Trecroci, 2008. "The Phillips Curve and the Italian Lira, 1861-1998," Mo.Fi.R. Working Papers 8, Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences.
  4. Alberto Bisin & John Geanakoplos & Piero Gottardi & Enrico Minelli & Heracles Polemarchakis, 2009. "Markets and Contracts," Working Papers 0915, University of Brescia, Department of Economics.
  5. Alessandro Fedele & Paolo M. Panteghini & Sergio Vergalli, 2010. "Optimal Investment and Financial Strategies under Tax Rate Uncertainty," Working Papers 2010.68, Fondazione Eni Enrico Mattei.
  6. Martin Meier & Enrico Minelli & Herakles Polemarchakis, 2009. "Competitive Markets with Private Information on Both Sides," Working Papers 0917, University of Brescia, Department of Economics.
  7. Alessandro Fedele & Francesco Liucci & Andrea Mantovani, 2009. "Credit availability in the crisis: the European investment bank group," Working Papers 0913, University of Brescia, Department of Economics.
  8. Francesco Menoncin & Paolo Panteghini, 2009. "Retrospective Capital Gains Taxation in the Real World," CESifo Working Paper Series 2674, CESifo Group Munich.
  9. Rosella Levaggi & Francesco Menoncin, 2009. "Decentralized provision of merit and impure public goods," Working Papers 0909, University of Brescia, Department of Economics.

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