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Portfolio Choice for HARA Investors: When Does 1/γ (not) Work?

Author

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  • Günter Franke

    () (Department of Economics, University of Konstanz, Germany)

  • Ferdinand Graf

    () (Department of Economics, University of Konstanz, Germany)

Abstract

In the continuous time-Merton-model the instantaneous stock proportions are inversely proportional to the investor’s local relative risk aversion γ. This paper analyses the conditions under which a HARA-investor can use this 1/γ-rule to approximate her optimal portfolio in a finite time setting without material effects on the certainty equivalent of the portfolio payoff. The approximation is of high quality if approximate arbitrage opportunities do not exist and if the investor’s relative risk aversion is higher than that used for deriving the approximation portfolio. Otherwise, the approximation quality may be bad.

Suggested Citation

  • Günter Franke & Ferdinand Graf, 2010. "Portfolio Choice for HARA Investors: When Does 1/γ (not) Work?," Working Paper Series of the Department of Economics, University of Konstanz 2010-11, Department of Economics, University of Konstanz.
  • Handle: RePEc:knz:dpteco:1011
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    File URL: http://www.uni-konstanz.de/FuF/wiwi/workingpaperseries/WP_Franke-Graf-11-10.pdf
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    References listed on IDEAS

    as
    1. Ait-Sahalia, Yacine & Lo, Andrew W., 2000. "Nonparametric risk management and implied risk aversion," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 9-51.
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    More about this item

    Keywords

    HARA-utility; portfolio choice; certainty equivalent; approximated choice;

    JEL classification:

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

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