Choosing and Using Utility Functions in Forming Portfolios

Geoffrey J. Warren

doi:10.1080/0015198X.2019.1618109

Choosing and Using Utility Functions in Forming Portfolios

Geoffrey J. Warren^*

^*Corresponding author for this work

Research output: Contribution to journal › Article › peer-review

13 Citations (Scopus)

Abstract

Utility functions offer a means to encode objectives and preferences in investor portfolios. The functions allow one to place a score on outcomes and then identify optimal portfolios by maximizing utility. The central theme of this article is that utility functions should be tailored to the investor. I discuss how an appropriate function might be chosen and demonstrate concepts for power utility and reference-dependent utility. A modeling approach is presented that may be applied without resorting to dynamic optimization. The selection of utility functions is illustrated for four investor types.

Original language	English
Pages (from-to)	39-69
Number of pages	31
Journal	Financial Analysts Journal
Volume	75
Issue number	3
DOIs	https://doi.org/10.1080/0015198X.2019.1618109
Publication status	Published - 2019

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10.1080/0015198X.2019.1618109

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Choosing and Using Utility Functions in Forming Portfolios

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