Creating portfolio risk and return models [47]

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Bullet points include: Original focus was on cardinal measures of utility More recent focus on ordinal measures, i.e. ones that focus on preferences, e.g. Von Neumann and Morgenstern (1944). A lottery might e.g. involve options Ai with probabilities pi, and we might assume axioms of expected utility theory apply, where “A < B” means agent prefers B to A and “A = B” means agent prefers them equally: Completeness: A < B, A = B or B < A Transitivity: if A < B and B < C then A < C Convexity/continuity: A < B < C then there is a p between 0 and 1 for which agent prefers pA + (1-p)C and B equally Independence: if A = B then pA + (1-p)C = pB +(1-p)C for all p between 0 and 1 N.B. Assumes the pi are knowable (c.f. Knightian uncertainty)

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