Higher-order risk preferences, constant relative risk aversion and the optimal portfolio allocation
Series: Working Papers. 1520.
Author: Trino-Manuel Ñíguez, Ivan Paya, David Peel and Javier Perote.
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Abstract
We derive the conditions for the optimal portfolio choice within a constant relative risk aversion type of utility function considering alternative probability distributions that are able to capture the asymmetric and leptokurtic features of asset returns. We illustrate the role —beyond risk aversion— played by higher-order moments in the optimal decision to form a portfolio of risky assets. In particular, we show that higher-order risk attitudes such as prudence and temperance associated with the third and fourth moments of the distribution define different optimal portfolios than those constrained under risk aversion.