Portfolio Allocation

Abstract

In his seminal work, Markowitz (1952) describes how an investor should allocate her wealth when asset returns are normally distributed. In this context, the optimization problem reduces itself to a mere mean-variance analysis. However, when returns are non-normal, the mean-variance criterion may fail to select the optimum portfolio. Its relevance depends in fact on the preferences of the investor. If she only cares about mean and variance of her portfolio, nothing has to be changed in the non-normal case. In the general case, however (for instance, for a constant relative risk averse investor), higher moments of the return distribution have to be taken into account in the asset allocation problem. This issue has been raised by a number of authors going back to Rubinstein (1973) and Kraus and Litzenberger (1976). In this context, asset allocation is more demanding and sometimes simply intractable.