Mean-variance vs. full-scale optimization: broad evidence for the U.K
In the Full-Scale Optimization approach the complete empirical financial return probability distribution is considered, and the utility maximising solution is found through numerical optimization. Earlier studies have shown that this approach is useful for investors following non-linear utility functions (such as bilinear and S-shaped utility) and choosing between highly non-normally distributed assets, such as hedge funds. We clarify the role of (mathematical) smoothness and differentiability of the utility function in the relative performance of FSO among a broad class of utility functions. Using a portfolio choice setting of three common assets (FTSE 100, FTSE 250 and FTSE Emerging Market Index), we identify several utility functions under which Full-Scale Optimization is a substantially better approach than the mean variance approach is. Hence, the robustness of the technique is illustrated with regard to asset type as well as to utility function specification.
|Date of creation:||2007|
|Contact details of provider:|| Postal: P.O. Box 442, St. Louis, MO 63166|
Web page: http://www.stlouisfed.org/
More information through EDIRC
|Order Information:|| Email: |
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.:
- J. Tobin, 1958.
"Liquidity Preference as Behavior Towards Risk,"
Review of Economic Studies,
Oxford University Press, vol. 25(2), pages 65-86.
- James Tobin, 1956. "Liquidity Preference as Behavior Towards Risk," Cowles Foundation Discussion Papers 14, Cowles Foundation for Research in Economics, Yale University.
- Gourieroux, C. & Monfort, A., 2005. "The econometrics of efficient portfolios," Journal of Empirical Finance, Elsevier, vol. 12(1), pages 1-41, January.
- Arditti, Fred D, 1969. "A Utility Function Depending on the First Three Moments: Reply," Journal of Finance, American Finance Association, vol. 24(4), pages 720-720, September.
- 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 915-919, September.
- Paul A. Samuelson, 1970. "The Fundamental Approximation Theorem of Portfolio Analysis in terms of Means, Variances and Higher Moments," Review of Economic Studies, Oxford University Press, vol. 37(4), pages 537-542.
- Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-291, March.
- Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
- 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.
- 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 308-317, June. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:fip:fedlwp:2007-016. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Anna Xiao)
If references are entirely missing, you can add them using this form.