Identification of investor's risk aversion in portfolio optimization

Alexei V. Gretchikha

Journal of Risk

Abstract: ABSTRACT Portfolio optimization requires investor's risk aversion to be specified. Without efficient procedures for identifying risk aversion in practical situations, investors can overexpose themselves to risk or lose profits. This paper describes the notion of risk aversion and the measures of portfolio performance used in practice: the distribution of accumulated wealth and potential interim losses. The results are intended to help investors analyze important aspects of their gain/risk preferences, identify the risk aversion that adequately describes them, and thereby more efficiently use portfolio optimization procedures that contain risk aversion as a parameter.

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