Risk aversion, prudence, and asset allocation: a review and some new developments

Michel Denuit () and Louis Eeckhoudt

Theory and Decision, 2016, vol. 80, issue 2, 227-243

Abstract: In this paper, we consider the composition of an optimal portfolio made of two dependent risky assets. The investor is first assumed to be a risk-averse expected utility maximizer, and we recover the existing conditions under which all these investors hold at least some percentage of their portfolio in one of the assets. Then, we assume that the decision maker is not only risk-averse, but also prudent and we obtain new minimum demand conditions as well as intuitively appealing interpretations for them. Finally, we consider the general case of investor’s preferences exhibiting risk apportionment of any order and we derive the corresponding minimum demand conditions. As a byproduct, we obtain conditions such that an investor holds either a positive quantity of one of the assets (positive demand condition) or a proportion greater than 50 % (i.e., the “50 % rule”). Copyright Springer Science+Business Media New York 2016

Keywords: Optimal portfolio; Diversification; Risk aversion; Downside risk; Prudence; Risk apportionment (search for similar items in EconPapers)
Date: 2016
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Working Paper: Risk aversion, prudence, and asset allocation: a review and some new developments (2015)
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DOI: 10.1007/s11238-015-9503-2

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