I.A.1.6.1 The Criterion (Mean-Variance Criterion)

Question 1

Mean-Cariance criterion

Answer 1

• maximise {E[X] - Var(X)/2λ}
  
  • E[X] - expeted value
  • Var(X) - variance
  • λ - characterises the risk tolerance of the decision maker

Question 2

Mean-Cariance criterion (other uncertainties)

Answer 2

• maximise {E[X] +E[Y] - (Var(X) +2Cov(x,Y))/2λ}
  
  • E[X] - expeted value
  • Var(X) - variance
  • λ - characterises the risk tolerance of the decision maker
• Ex: If one already holds a portfolio with returns Y and is considering investing in an additional portfolio with returns X, the decision will be affected byt the diversification potential, that is, the covariance between Y and X