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෪𝑗
𝑊 𝐸 𝑊𝑗
= 𝐸[ −1− + 1]2
𝑊0 𝑊0
2
1 𝜎𝑊
෪𝑗 − 𝐸 𝑊𝑗 ]2 =
= 2 𝐸[𝑊
𝑊0 𝑊02
Using mean and variance as choice criteria
• Assuming asset returns are normally distributed, with
mean 𝐸 and standard deviation 𝜎, utility function will
be: (Tobin (1958):
𝑈 = 𝑈 𝑅𝑗 , 𝐸, 𝜎
• Expectred utility
• Where
𝑓(𝑅; E; 𝜎) là is distribution of 𝑅
Using mean and variance as choice criteria
• Relationship between return and risk
for risk averter:
• Expressed through indifference curves:
set of investment opportunities with the
same 𝐸(𝑈)
• That indifference curve is increasing and
concave (second derivative >0)
• Only applied for risk averter
Indifference curve of risky investments
• Prove that indifference curve is increasing
function
• Change from normal distribution to (0, 1) distribution:
෨
𝑅~𝑁 ෨
𝜇, σ → 𝑍~𝑁(0,1)
Indifference curve of risky investments
• Because investors are indifferent among investment opportunities:
∞ ∞
𝑑𝐸
0= න 𝑈 ′ (𝐸 + 𝜎𝑍)f Z; 0; 1 dZ + න 𝑈 ′ (𝐸 + 𝜎𝑍)Zf Z; 0; 1 dZ
𝑑𝜎
−∞ −∞
∞
𝑑𝐸 −∞ 𝑈 ′ (𝐸+𝜎𝑍)Zf Z;0;1 dZ
=− ∞ > 0 ??
𝑑𝜎 −∞ 𝑈 ′ (𝐸+𝜎𝑍)f Z;0;1 dZ
Indifference curve of risky investments
∞
𝑑𝐸 −∞ 𝑈 ′ (𝐸+𝜎𝑍)Zf Z;0;1 dZ
=− ∞ >0
𝑑𝜎 −∞ 𝑈 ′ (𝐸+𝜎𝑍)f Z;0;1 dZ
• Denominator >0
bec𝑎𝑢𝑠𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑎𝑠𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑡ℎ𝑎𝑡 𝑚𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑢𝑡𝑖𝑙𝑖𝑡𝑦
𝑈 ′ (𝐸 + 𝜎𝑍) > 0
• Nominator <0 because
“marginal utility when 𝑍 < 0” > “marginal utility
when 𝑍 > 0"
→ Increasing function
Mean – Variance paradox
Hạn chế khi sử dụng phương pháp mean-variance
State of economy
Recessio Bad Normal Good Boom
n
Operating profit
Probability
Firm A
Interest
Tax 50%
Net income
Firm B
Interest
Tax 50%
Net income
($1.41, $5)