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Maximum Certain Equivalent Excess Returns and Equivalent Preference Criteria Part I - Theory

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  • Jacques Pézier

    (ICMA Centre, University of Reading)

Abstract

Generalizations of traditional preference criteria such as the Sharpe ratio, the information ratio and the Jensen alpha are obtained by maximizing a certain equivalent excess return (CER) under relevant investment conditions. They are increasing functions of CERs and therefore equivalent criteria. They are consistent with utility theory and are applicable to any investment choice. That is not the case for many other popular preference criteria (e.g., Omega index, Sortino ratio, expected shortfall and so-called 'coherent' preference criteria). Most are incompatible with expected utility maximization and therefore best avoided.

Suggested Citation

  • Jacques Pézier, 2007. "Maximum Certain Equivalent Excess Returns and Equivalent Preference Criteria Part I - Theory," ICMA Centre Discussion Papers in Finance icma-dp2008-05, Henley Business School, University of Reading, revised Dec 2008.
    • Handle: RePEc:rdg:icmadp:icma-dp2008-05
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Certain equivalent excess return; risk adjusted performance measures; risk aversion; power utility functions; coherent risk measures; spectral indices; Sharpe ratio; generalized Sharpe ratio; information ratio; Treynor ratio; Jensen alpha; skewness; kurtosis; downside risk measures; expected shortfall; Sortino ratio; Omega ratio;
    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

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