Why would maximizing expectation on a concave utility function lead to losing your shirt? It seems like any course of action that predictably leads to losing your shirt is self-evidently not maximizing expected concave-utility-function, unless it's a Pascal mugging type scenario. I don't think there are credible Pascal muggings in the world of personal finance, and if there are I'd be willing to accept an ad hoc axiom that we limit our theory to more conventional investments.

Now, I'll admit it's possible we should have a loss averse utility function, but we can do that without abandoning the mathematical approach--just add a time derivative of wealth, or something.

Why would maximizing expectation on a concave utility function lead to losing your shirt?

Because you're ignoring risk.

The expectation is a central measure of a distribution. If that's the only thing you look at, you have no idea about the width of your distribution. How long and thick is that left tail which is curling around preparing to bite you in the ass? Um, you don't know.

Open thread, Apr. 18 - Apr. 24, 2016

by MrMind 1 min read18th Apr 2016176 comments

2


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