39 Pages Posted: 28 May 2004
Date Written: January 2004
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: 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
By Dušan Isakov