Conditional Asset Allocation Under Non-Normality: How Costly is the Mean-Variance Criterion?

42 Pages Posted: 26 Feb 2005

See all articles by Eric Jondeau

Eric Jondeau

University of Lausanne - Faculty of Business and Economics (HEC Lausanne); Swiss Finance Institute; Swiss Finance Institute

Michael Rockinger

University of Lausanne - School of Economics and Business Administration (HEC-Lausanne); Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Date Written: February 2005

Abstract

We evaluate how departure from normality may affect the conditional allocation of wealth. The expected utility function is approximated by a fourth-order Taylor expansion that allows for non-normal returns. Market returns are characterized by a joint model that captures the time dependency and the shape of the distribution. We show that under large departure from normality, the mean-variance criterion can lead to portfolio weights that differ significantly from those obtained using the optimal strategy accounting for non-normality. In addition, the opportunity cost for a risk-adverse investor to use the sub-optimal mean-variance criterion can be very large.

Keywords: Volatility, Skewness, Kurtosis, GARCH, model, Multivariate skewed Student-t distribution, Stock returns, Asset allocation, Emerging markets

JEL Classification: C22, C51, G12

Suggested Citation

Jondeau, Eric and Rockinger, Georg Michael, Conditional Asset Allocation Under Non-Normality: How Costly is the Mean-Variance Criterion? (February 2005). Available at SSRN: https://ssrn.com/abstract=674424 or http://dx.doi.org/10.2139/ssrn.674424

Eric Jondeau

University of Lausanne - Faculty of Business and Economics (HEC Lausanne) ( email )

Extranef 232
Lausanne, 1012
Switzerland
+41 21 692 33 49 (Phone)

HOME PAGE: http://people.unil.ch/ericjondeau/

Swiss Finance Institute ( email )

40, Boulevard du Pont-d'Arve
40, Bd du Pont-d'Arve
1211 Geneva 4, CH-6900
Switzerland
+41 21 692 33 49 (Phone)

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Georg Michael Rockinger (Contact Author)

University of Lausanne - School of Economics and Business Administration (HEC-Lausanne) ( email )

Unil Dorigny, Batiment Internef
Lausanne, 1015
Switzerland
+41 21 728 3348 (Phone)
+41+21 692 3435 (Fax)

HOME PAGE: http://www.hec.unil.ch/mrockinger

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland