FIN 010 Lecture Notes - Lecture 22: Santa Barbara City College, Risk Aversion, Risk-Seeking
Document Summary
How % wealth invested in risky assets changes and wealth changes. No consensus on how rra changes as wealth changes. Quadratic u function: u(w) = w cw2. Exponential u, power u (not covered in this course) One of two: when is the use of e(r) and stdv appropriate to approximate investor preferences: normal distribution of e(r) (the return, u functions are quadratic (the investor) Issues with 2. : quadratic implies investors become satiated, and implies increasing. Simplify to u = e(r) a 2. A=0 = risk neutral investor, for rational investor (risk averse) a>0. Higher a = higher risk averse = higher risk penalty. More risk adds to u for a risk seeking investor. Nw rule for risk averse (steeper is more risk averse) Aka choose higher return and lower risk -> nw selection rule. The combinations of risky assets that minimise portfolio var for given level of portfolio e(r)
