ABSTRACT
This chapter reviews elements of Utility theory. Utility theory can be of use when there are a number of investment alternatives and an investor is to allocate J. Ingersoll, Jr. wealth among the alternatives. Given an allocation, his wealth at the end of some time horizon is determined by the outcomes for the various investment alternatives. The chapter also reviews the genesis of utility theory — the St. Petersburg paradox, elements of an axiomatic approach to utility theory, defines risk aversion, introduces several popular utility functions and discusses field studies. Utility theory has also been criticized because an investor’s utility function cannot be observed directly.
