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The portfolio choice problem: comparison of certainty equivalence and optimal Bayes portfolios
Authors:Stephen J Brown
Institution:Bell Laboratories , Murray Hill, New Jersey
Abstract:For the portfolio problem with unknown parameter values, we compare the conventional certainty equivalence portfolio choice with the optimal Bayes portfolio. In the important single risky asset case a diffuse Bayes rule leads to portfolios that differ significantly from those suggested by a certainty equivalence rule which we show are inadmissible relative to a quadratic utility function for the range of parameters we consider. These results are invariant to arbitrary changes in the utility function parameters. We illustrate the results using a simple mutual fund example.
Keywords:diffuse prior  predictive distribution  risk function  security returns  single risky asset
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