Working Paper: NBER ID: w1611
Authors: Benjamin M. Friedman; V. Vance Roley
Abstract: The three sections of this paper support three related conclusions. First, asset demands with the familiar properties of wealth homogeneity and linearity in expected returns follow as close approximations from expected utility maximizing behavior under the assumptions of constant relative risk aversion and joint normally distributed asset returns. Second, although such asset demands exhibit a symmetric coefficient matrix with respect to the relevant vector of expected asset returns, symmetry is not a general property, and the available empirical evidence warrants rejecting it for both institutional and individual investors in the United States. Finally, in a manner analogous to the finite maximum exhibited by quadratic utility, a broad class of mean-variance utility functions also exhibits a form of wealth satiation which necessarily restricts it range of applicability.
Keywords: Investor Behavior; Risk; Expected Utility; Asset Demands; Wealth Satiation
JEL Codes: D81; G11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| empirical evidence contradicts the assumption of symmetry in asset demands (D11) | portfolio behavior does not exhibit symmetric responses to expected asset returns (G11) |
| expected utility maximization (D81) | asset demands characterized by wealth homogeneity and linearity in expected returns (G19) |
| constant relative risk aversion and joint normality of asset returns (D81) | expected utility maximization (D81) |
| certain levels of initial wealth (D14) | decrease in marginal utility (D11) |
| wealth satiation in mean-variance utility functions (D11) | investors may divest some wealth to maximize utility (G11) |