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Creating portfolio risk and return models [46]

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Bullet points include: Natural mathematical formulation is something akin to regime-switching, or some continuous analogue. Adds a lot of mathematical complexity Depends on you being able to tell which ‘regime’ you are in and what its characteristics are And problem becomes utility dependent The overall conditional distributional form is no longer multivariate Normal; The investor’s utility is no longer therefore necessarily merely a function of the mean and covariance matrix of the distributional form; and The investor’s utility function is no longer therefore necessarily equivalent, in terms of the portfolio weights derived from it, to a quadratic utility function as per traditional mean-variance optimisation.

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