A Tractable Utility-Based Approach to Consistent Model Selection and Asset Allocation

18 Pages Posted: 27 Oct 2005  

Craig A. Friedman

TIAA-CREF

Sven Sandow

Standard & Poor's - Quantitative Analytics

Date Written: May 12, 2004

Abstract

Investors, such as traders and portfolio managers, who face the practical problem of how to allocate their assets in financial markets, often use probabilistic models, in conjunction with some quantification of their preferences. In this paper, we explore a consistent, tractable framework, based on utility theory, for both selecting models and allocating assets. This framework leads us to a particular family of utility functions, the generalized logarithmic family, which is consistent with model selection via likelihood. We also discuss drawdown and optimality consequences of applying this framework as well as related calibration issues.

Keywords: Likelihood Ratio, Drawdown Probability, Optimal Performance, Generalized Logarithmic Utility Function

Suggested Citation

Friedman, Craig A. and Sandow, Sven, A Tractable Utility-Based Approach to Consistent Model Selection and Asset Allocation (May 12, 2004). Available at SSRN: https://ssrn.com/abstract=827304 or http://dx.doi.org/10.2139/ssrn.827304

Craig A. Friedman (Contact Author)

TIAA-CREF ( email )

730 3rd Ave
New York, NY 10017
United States

Sven Sandow

Standard & Poor's - Quantitative Analytics ( email )

55 Water Street
New York, NY 10041
United States

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