A Course on Statistics for Finance

Chapter 7

Utility-Based Portfolio Analysis

7.1 Introduction

This chapter and the preceding one form a unit on portfolio analysis. In this chapter, the notion of single-criterion portfolio analysis is continued from the preceding chapter. Here, a criterion that combines portfolio mean and variance is derived.

7.1.1 Background

To review, recall that bi-criterion portfolio analysis, or mean-variance analysis, is based on the mean and variance of portfolio ROR. A good portfolio is one with a good combination of portfolio mean ROR µp and variance ${\sigma }_p^2$ of portfolio ROR, namely, relatively high mean and relatively low variance. The possible combinations are usually represented in a plot of mean versus standard deviation or mean versus variance. ...