6 Risk Aversion and Capital Allocation to Risky Assets

6 Risk Aversion and Capital Allocation to Risky Assets -...

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Unformatted text preview: Comm367 1 Risk Aversion and Capital Allocation to Risky Assets Comm367 2 The Utility Function • Choice between expected return and risk, the latter measured by the variance or standard deviation • Quadratic utility U = E(r) - (½)Aσ2 U = utility E ( r ) = expected return on the asset or portfolio A = coefficient of risk aversion Comm367 3 Table 6.1 Available Risky Portfolios (Risk-free Rate = 5%) Comm367 4 Table 6.2 Utility Scores of Alter. Portfolios for Investors with Varying Risk Aversion Comm367 5 Figure 6.1 The Trade-off Between Risk and Returns of a Potential Investment Portfolio Comm367 6 Figure 6.2 The Indifference Curve Comm367 7 Table 6.3 Utility Values of Possible Portfolios for an Investor with Risk Aversion, A = 4 Comm367 8 • Possible to split investment funds between safe and risky assets • Risk free asset: proxy; T-bills • Risky asset: stock (or a portfolio) Allocating Capital Between Risky & Risk Free Assets Comm367 9 • Examine risk/return tradeoff • Demonstrate how different degrees of risk aversion will affect allocations between risky and risk free assets • Example: page 180-182, Bodie 6 CE Allocating Capital Between Risky & Risk Free Assets Comm367...
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This note was uploaded on 08/03/2011 for the course ECON 503 taught by Professor Motherfucker during the Spring '11 term at Aarhus Universitet.

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6 Risk Aversion and Capital Allocation to Risky Assets -...

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