On the quality of Taylor approximations to expected utility

• Autores: Georgios Skoulakis
• Localización: Applied financial economics, ISSN 0960-3107, Vol. 22, Nº. 10-12, 2012, págs. 863-876
• Idioma: inglés
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• Resumen

  • This article presents evidence on the quality of Taylor series approximations to expected utility. To provide a transparent assessment in a broader setting, we assume that log portfolio returns follow a Gram�Charlier distribution that incorporates skewness and excess kurtosis and consider an investor with Constant Relative Risk Aversion (CRRA) preferences. In this framework, we obtain closed-form approximations to expected utility based on Taylor expansions with respect to gross and log portfolio return. We illustrate the quality of the two approximations across a wide range of scenarios in terms of distribution parameters and levels of risk aversion. The Taylor expansion with respect to log portfolio return is shown to produce reliable approximations.