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Increases in risk and optimal portfolio

Author

Listed:
  • Georges Dionne

    (HEC Montreal, Canada Research Chair in Risk Management)

  • François Gagnon

    (Caisse de dépôt et placement du Québec)

  • Kaïs Dachraoui

    (Université de Montréal)

Abstract

We study the effect of riskiness on optimal portfolio. As discussed by Levy (1992), the main drawback of the standard model with one decision variable and one risky asset developed over the last twenty-five years, following the contributions of Rothschild and Stiglitz (1970, 1971) and Hadar and Russell (1969), is in the area of finance since this framework is not appropriate to study portfolio diversification. Our purpose is to answer the following question: How a mean preserving spread on the returns of a given asset affect the composition of an optimal portfolio with two risky assets and one riskless asset? We propose a methodology to answer this difficult question and we show that we must introduce different restrictions on the set of von Newman-Morgenstern utility functions and that of returns distribution functions to obtain intuitive results. However, we do not have to limit the analysis to the mean-variance model.

Suggested Citation

  • Georges Dionne & François Gagnon & Kaïs Dachraoui, 1998. "Increases in risk and optimal portfolio," Working Papers 97-11, HEC Montreal, Canada Research Chair in Risk Management.
    • Handle: RePEc:ris:crcrmw:1997_011
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    References listed on IDEAS

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    2. Meyer, Jack & Ormiston, Michael B, 1994. "The Effect on Optimal Portfolios of Changing the Return to a Risky Asset: The Case of Dependent Risky Returns," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 35(3), pages 603-612, August.
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    Cited by:

    1. Georges Dionne & Scott Harrington, 2017. "Insurance and Insurance Markets," Working Papers 17-2, HEC Montreal, Canada Research Chair in Risk Management.

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    Keywords

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    JEL classification:

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

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