ABSTRACT
By contrast, the two topics in this chapter deal with the attitudes of individual investors in relation to investment decisions where these decisions are subjective in nature. The first is the notion of an investor’s individual utility function. In a deterministic model it is reasonable to expect that an investor will seek to choose an investment portfolio of assets in order to maximize the final wealth that he achieves. When the model is stochastic the investor’s final wealth will typically be a random variable,W , and it would no longer make sense for him to make investment decisions seeking to maximize a random quantity. Instead, he might wish to maximize the expected value of his final wealth, E.W /, so that he achieves the largest wealth on average, or more generally it is often postulated that he seeks to maximize Ev.W / for some appropriate function v./; this function is referred to as the investor’s utility function. It is individual to the investor and we show in Section 1.2 that any investor who orders his preferences of random outcomes in a suitably consistent way possesses an essentially unique utility function and that properties of this function may characterize his attitude towards risk.
