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Increases in risk and optimal portfolio

Author

Listed:
  • Dionne, Georges

    (HEC Montreal, Canada Research Chair in Risk Management)

  • Gagnon, François

    (Caisse de dépôt et placement du Québec)

  • Dachraoui, Kaïs

    (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

  • Dionne, Georges & Gagnon, François & Dachraoui, Kaïs, 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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    File URL: https://www.risksresearch.com/_files/ugd/a6eed3_11952d4ba80349e487a09324ed0bf53c.pdf
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    Cited by:

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

    More about this item

    Keywords

    Optimal portfolio; riskiness; increases in risk; mean preserving spread; portfolio returns; returns distribution;
    All these keywords.

    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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