The Geometry of Separation and Myopia

Michael Brennan and A. Kraus

Journal of Financial and Quantitative Analysis, 1976, vol. 11, issue 2, 171-193

Abstract: In recent years a number of papers have been concerned with the determination of necessary and sufficient conditions for portfolio separation and for myopia. As a result of these earlier investigations, it is known that a necessary and sufficient condition both for portfolio separation and for myopia is that the investor's utility function exhibit risk tolerance, that is a linear function of wealth. What is lacking in the existing literature is a clear demonstration of the economic relevance of linear risk tolerance for portfolio separation and myopia. It is hoped that this paper will help to fill the gap by an analysis of separation and myopia using the standard tools of price theory: indifference curves, budget lines, and Engel curves. Viewed in this perspective, a substantial part of the analysis can be amplified and clarified in terms of the geometry of the situation.

Date: 1976
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