Expected Utility Asset Allocation

Most asset allocation analyses use the mean–variance approach for analyzing the trade-off between risk and expected return. Analysts use quadratic programming to find optimal asset mixes and the characteristics of the capital asset pricing model to determine reasonable optimization inputs. This article presents an alternative approach in which the goal of asset allocation is to maximize expected utility, where the utility function may be more complex than that associated with mean–variance analysis. Inputs for the analysis are based on the assumption of asset prices that would prevail if there were a single representative investor who desired to maximize expected utility.