Determination and estimation of risk aversion coefficients

Taras Bodnar, Yarema Okhrin (), Valdemar Vitlinskyy and Taras Zabolotskyy
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Taras Bodnar: Stockholm University
Yarema Okhrin: University of Augsburg
Valdemar Vitlinskyy: Kyiv National Economic University
Taras Zabolotskyy: Ivan Franko Lviv National University

Computational Management Science, 2018, vol. 15, issue 2, No 8, 297-317

Abstract: Abstract In the paper we consider two types of utility functions often used in portfolio allocation problems, i.e. the exponential utility and the quadratic utility. We link the resulting optimal portfolios obtained by maximizing these utility functions to the corresponding optimal portfolios based on the minimum value-at-risk (VaR) approach. This allows us to provide analytic expressions for the risk aversion coefficients as functions of the VaR level. The results are initially derived under the assumption that the vector of asset returns is multivariate normally distributed and they are generalized to the class of elliptically contoured distributions thereafter. We find that the choice of the coefficients of risk aversion depends on the stochastic model used for the data generating process. Finally, we take the parameter uncertainty into account and present confidence intervals for the risk aversion coefficients of the considered utility functions. The theoretical results are validated in an empirical study.

Keywords: Risk aversion; Exponential utility; Quadratic utility; Elliptically contoured distributions; Laplace distribution; Parameter uncertainty (search for similar items in EconPapers)
JEL-codes: C13 C18 C44 C54 C58 G11 G15 G32 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (9)

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DOI: 10.1007/s10287-018-0317-x

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