Portfolio Choice for HARA Investors: When Does 1/γ (not) Work?

Günter Franke () and Ferdinand Graf ()
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Ferdinand Graf: Department of Economics, University of Konstanz, Germany

No 2010-11, Working Paper Series of the Department of Economics, University of Konstanz from Department of Economics, University of Konstanz

Abstract: In the continuous time-Merton-model the instantaneous stock proportions are inversely proportional to the investor’s local relative risk aversion γ. This paper analyses the conditions under which a HARA-investor can use this 1/γ-rule to approximate her optimal portfolio in a finite time setting without material effects on the certainty equivalent of the portfolio payoff. The approximation is of high quality if approximate arbitrage opportunities do not exist and if the investor’s relative risk aversion is higher than that used for deriving the approximation portfolio. Otherwise, the approximation quality may be bad.

Keywords: HARA-utility; portfolio choice; certainty equivalent; approximated choice (search for similar items in EconPapers)
JEL-codes: D81 G10 G11 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2010-11-04
New Economics Papers: this item is included in nep-upt
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