Utility Theory-Based Portfolio Choice

Graham Giller

Chapter 3 in Essays on Trading Strategy, 2023, pp 51-71 from World Scientific Publishing Co. Pte. Ltd.

Abstract: In this essay, I will present solutions to the “frictionless” asset allocation problem for several probability distributions that are leptokurtotic, meaning that they possess significant density in the tails. In this context, frictionless means without transaction costs. These probability densities all share the trait that the mean and variance are not sufficient statistics for the distribution and we will see that the solutions differ from the linear holding function (ht ∝ αt). I will begin with a summary of utility theory that is intended to provide the context within which the solutions are developed. The goal is not to refine utility theory, or discuss its suitability for the solution of trading strategy problems, but to use it as a tool to exhibit this feature of the holding function.

Keywords: Stock Market; Stock Trading; Decision Theory; Optimal Trading; Trading Strategy; Finance; Optimization; Portfolio Strategy; Modern Portfolio Theory; Kelly Criterion; Betting Strategy; Risk Management; Tail Risk; Investment Management; Performance Measurement; Sharpe Ratio; Trading Theory; Investment Theory (search for similar items in EconPapers)
JEL-codes: G1 G11 (search for similar items in EconPapers)
Date: 2023
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