D.1.1 Markowitz Preferences

State the expected utility function that describes a Markowitz-type investor. Use math notation and explain the meaning of each term.

E[U(wp)]=E[γ(wp)] - γ/2*Var[γ(wp)]

wp: vector of portfolio weight

γ(wp): return of portfolio wp

IDEA: r(wp): return of portfolio wp → should also be changed in function

γ: risk aversion

E: expected operator

Var: Variance

U(wp):Utility from holding wp

D.1.2 Markowitz Approach to Asset Management

Name and explain the three layers of a Markowitz optimal asset selection procedure.

First layer: try to find what does an investor want?

Second layer: choose portfolio to max investor’s happiness

Third layer: probability density function of optimal portfolio wp*

ALT:

1. Input Data
   • the probability distribution of all assets holding-period returns
   • an exact description of what makes an investor happy
2. Investor´s Active decision making
3. Characterizing Return Density of Optimal portfolio