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Utility Theory-Based Portfolio Choice

In: Essays on Trading Strategy

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  • Graham L. Giller

Abstract

In this essay, I will present solutions to the “frictionless” asset allocation problem for several probability distributions that are leptokurtotic, meaning that they possess significant density in the tails. In this context, frictionless means without transaction costs. These probability densities all share the trait that the mean and variance are not sufficient statistics for the distribution and we will see that the solutions differ from the linear holding function (ht ∝ αt). I will begin with a summary of utility theory that is intended to provide the context within which the solutions are developed. The goal is not to refine utility theory, or discuss its suitability for the solution of trading strategy problems, but to use it as a tool to exhibit this feature of the holding function.

Suggested Citation

  • Graham L. Giller, 2023. "Utility Theory-Based Portfolio Choice," World Scientific Book Chapters, in: Essays on Trading Strategy, chapter 3, pages 51-71, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789811273827_0003
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    Keywords

    Stock Market; Stock Trading; Decision Theory; Optimal Trading; Trading Strategy; Finance; Optimization; Portfolio Strategy; Modern Portfolio Theory; Kelly Criterion; Betting Strategy; Risk Management; Tail Risk; Investment Management; Performance Measurement; Sharpe Ratio; Trading Theory; Investment Theory;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G1 - Financial Economics - - General Financial Markets

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