Optimal Portfolio Allocation Under Higher Moments

39 Pages Posted: 28 May 2004  

Eric Jondeau

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

Multiple version iconThere are 3 versions of this paper

Date Written: January 2004

Abstract

We evaluate how departure from normality may affect the allocation of assets. A Taylor series expansion of the expected utility allows to focus on certain moments and to compute numerically the optimal portfolio allocation. A decisive advantage of this approach is that it remains operational even if a large number of assets is involved. We show that under moderate non-normality the mean-variance criterion provides a good approximation of the expected utility maximization. In contrast, under large departure from normality (as found in some stocks in mature markets or in some stock indices in emerging markets), the mean-variance criterion may fail to approximate the expected utility correctly. In such cases, the three-moment or four-moment optimization strategies may provide a good approximation of the expected utility.

Keywords: Asset allocation, Stock returns, Non-normality, Utility function

JEL Classification: C22, C51, G12

Suggested Citation

Jondeau, Eric and Rockinger, Michael, Optimal Portfolio Allocation Under Higher Moments (January 2004). EFMA 2004 Basel Meetings Paper. Available at SSRN: https://ssrn.com/abstract=498322 or http://dx.doi.org/10.2139/ssrn.498322

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://www.hec.unil.ch/ejondeau/

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)

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)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Swiss Finance Institute

40, Boulevard du Pont-d'Arve
40, Bd du Pont-d'Arve
1211 Geneva 4, CH-6900
Switzerland

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