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Rationalization of Investment Preference Criteria

Abstract: The majority of risk adjusted performance measures (RAPM) currently in use - e.g., Treynor ratio, (?/?)) ratio, Omega index, RoVaR, 'coherent' preference criteria, etc. - are incompat- ible with any sensible utility function and would be best avoided. We argue instead for the assessment of a maximum certainty equivalent excess return (CER*) criterion, or equivalent criteria, adapted to investment circumstances: alternative investments, return forecasts, and risk attitude. We explain the assessment of CER*s and give three applications: performance comparisons among traditional and alternative funds, optimal design of structured products, and explanation of the credit risk premium puzzle.

Published on 1st September 2011
Authors Jacques Pézier
Series Reference 2011-12