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1 July 2019 Financial Analysts Journal Volume 75, Issue 3

Choosing and Using Utility Functions in Forming Portfolios

  1. Geoffrey J. Warren
Utility functions offer a means to encode objectives and preferences in investor portfolios. The functions allow one to place a score on outcomes and then identify optimal portfolios by maximizing utility. The central theme of this article is that utility functions should be tailored to the investor. I discuss how an appropriate function might be chosen and demonstrate concepts for power utility and reference-dependent utility. A modeling approach is presented that may be applied without resorting to dynamic optimization. The selection of utility functions is illustrated for four investor types.
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Publisher Information
Routledge doi.org/10.1080/0015198X.2019.1618109 ISSN/ISBN: 0015-198X

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