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I realize you guys are referring to EL code here for risk reward when
discussing Optimal f.
Just thought some others on the list like me would appreciate a clearer
definition. This in noway was mean't to improve on any conclusions reach
already from this discussion.
Robert
At 11:42 AM 6/11/00 -0500, robert.cummings@xxxxxxxxxxxxxxxx wrote:
>Here is a generalized explanation of the Optimal f when used for buying
>and selling stocks. Also managing portfolio's optimal factional
>investment in equities to maximize returns.
>
>http://www.portfolioinsight.com/optimalf.htm
>
>
>Robert
>
>
>At 12:25 PM 6/11/00 -0400, Bob Fulks wrote:
>>I did some more research on the topic of Utility Theory. There is a good
>>discussion in "Investments" by Bodie, Kane, & Marcus.
>>
>>When referring to a plot of "Annualized Return" vs. "Annualized Standard
>>Deviation of Returns", the Utility function of an individual can be
>>approximated by:
>>
>> Utility = Return - 0.5 * A * StdDev^2
>>
>>where A is some constant for that person.
>>
>>----------
>>If Utiity, Return, and StdDev are in percent the equation becomes:
>>
>> Utility = Return - 0.005 * A * StdDev^2)
>>----------
>>
>>The Indifference Curves would be a curves of a constant values of Utility
>>so rearranging:
>>
>> Return = Utility + 0.5 * A * StdDev^2
>>
>>So in my example, the curves for the Little Old Lady and the Young
>>Engineer would turn out to be give by the following values:
>>
>> A Utility
>> Little Old Lady 60.0 6.4%
>> Young Engineer 4.2 22.5%
>>
>>These two curves are plotted on Chart1a (see next message for the chart).
>>
>>People with a positive value of A are called "risk-averse". Most people
>>are risk-averse.
>>
>>A person who decides to trade at Optimal_f would have a value of A = 0.
>>Such people are called "risk-neutral".
>>
>>Some people even have a negative value of A. They are called
>>"risk-lovers". This would include people addicted to gambling. With
>>casino gambling, the expected return would be slightly negative (to allow
>>for the house's "take") but the negative A of those people would make the
>>Utility of this activity positive for them.
>>
>>I found this interesting. Thanks for all of the questions.
>>
>>Bob Fulks
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