Portfolio selection with probabilistic utility

We present a novel portfolio selection technique, which replaces the traditional maximization of the utility function with a probabilistic approach inspired by statistical physics. We no longer seek the single global extremum of some chosen utility function, but instead reinterpret the latter as a probability distribution of ‘optimal’ portfolios, and select the portfolio that is given by the mean value with respect to that distribution. This approach has several attractive features, when comparing it to the standard maximization of expected utility. First, it significantly reduces the over-pronounced sensitivity to external parameters that plague optimization procedures. Second, it mitigates the commonly observed concentration on too few assets; and third, it provides a natural and self consistent way to account for the incompleteness of information and the aversion to uncertainty. Empirical results supporting the proposed approach are presented by using artificial data to simula...

• Type: Journal
• Year: 2007
• Where: ANOR
• Authors: Robert Marschinski, Pietro Rossi, Massimo Tavoni, Flavio Cocco
• Keywords: ANOR 2007, Portfolio Selection Technique, Single Global Extremum, Utility Function