Optimal Portfolio Allocation Under Higher Moments
Eric Jondeau and Michael Rockinger*
Journal of the European Financial Management Association, 2006, 12(1), 29-55.
Abstract
We evaluate how departure from normality may affect the allocation of assets. A Taylor series expansion of the expected utility allows to focus on certain moments and to compute the optimal portfolio allocation numerically. A decisive advantage of this approach is that it remains operational even for a large number of assets. While the mean-variance criterion provides a good approximation of the expected utility maximization under moderate non-normality, it may be ineffective under large departure from normality. In such cases, the three-moment or four-moment optimization strategies may provide a good approximation of the expected utility.
Keywords: Asset allocation, Stock returns, Non-normality, Utility function.
JEL classification: C22, C51, G12.
* HEC Lausanne