The Risk of Expected Utility under Parameter Uncertainty

Nathan Lassance (), Alberto Martín-Utrera () and Majeed Simaan ()
Additional contact information
Nathan Lassance: Université catholique de Louvain, LIDAM/LFIN, Belgium
Alberto Martín-Utrera: Iowa State University
Majeed Simaan: Institute of Technology

No 2023011, LIDAM Reprints LFIN from Université catholique de Louvain, Louvain Finance (LFIN)

Abstract: We derive analytical expressions for the risk of an investor’s expected utility under parameter uncertainty. In particular, our analysis focuses on characterizing the out-of-sample utility variance of three portfolios: the classic mean-variance portfolio, the minimum-variance portfolio, and a shrinkage portfolio that combines both. We then use our analytical expressions to study a robustness measure that balances out-of-sample utility mean and volatility. We show that neither the sample mean-variance portfolio nor the sample minimum-variance portfolio exhibits maximal robustness individually, and one needs to combine both to optimize portfolio robustness. Accordingly, we introduce a robust shrinkage portfolio that delivers an optimal tradeoff between out-of-sample utility mean and volatility and is more resilient to estimation errors. Our results highlight the importance of considering out-of-sample performance risk in designing and evaluating investment strategies and stochastic discount factor models.

Keywords: Parameter uncertainty; mean-variance portfolio; shrinkage (search for similar items in EconPapers)
JEL-codes: G11 G12 (search for similar items in EconPapers)
Pages: 105
Date: 2023-08-18
Note: In: Management Science, 2023
References: Add references at CitEc
Citations: View citations in EconPapers (1)

There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ajf:louvlr:2023011

Access Statistics for this paper

More papers in LIDAM Reprints LFIN from Université catholique de Louvain, Louvain Finance (LFIN) Voie du Roman Pays 34, 1348 Louvain-la-Neuve (Belgium). Contact information at EDIRC.
Bibliographic data for series maintained by Séverine De Visscher ().