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utility functions???
Posted: February 24th, 2010, 7:29 pm
by selmabeyaz
Why people always try to maximize utility function of the terminal wealth in portfolio theory or gamble models? Is not it possible to maximize just terminal wealth. Why we need utility functions? I cannot find articles or books in which the aim is to maximize just terminal wealth.
utility functions???
Posted: February 24th, 2010, 7:40 pm
by DavidJN
Because terminal wealth maximization is inconsistent with diminishing marginal utility of wealth (and thus inconsistent with risk aversion) and can lead to pathological behavior. Read up on Daniel Bernoulli's ancient solution to the St. Petersburg Paradox for details.
utility functions???
Posted: February 24th, 2010, 8:02 pm
by selmabeyaz
Thank you very much for your help. I have a research project about the application of dynamic programming in portfolio optimization. I do not know much about portfolio optimization so I really need help. It would be great if you have any other suggestions for me.