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The Opportunity Cost of a Mean‐Variance Efficient Choice
Author(s) -
Tew Bernard V.,
Reid Donald W.,
Witt Craig A.
Publication year - 1991
Publication title -
financial review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.621
H-Index - 47
eISSN - 1540-6288
pISSN - 0732-8516
DOI - 10.1111/j.1540-6288.1991.tb00368.x
Subject(s) - variance (accounting) , portfolio , economics , liberian dollar , investment (military) , econometrics , fraction (chemistry) , actuarial science , financial economics , microeconomics , finance , chemistry , accounting , organic chemistry , politics , political science , law
The mean‐variance criterion is one of the most frequently used methods for selecting investment portfolios. Yet, because it is an approximation of an investor's maximum expected utility choice, some theoreticians and practitioners have criticized the approach. This paper examines the investment loss that different investors experience by accepting a mean‐variance efficient portfolio. Simulated security returns with extreme distributional characteristics are used to determine the extent of an investor's loss. The results indicate that even under very unreasonable investment distributional assumptions, an investor's loss by accepting a mean‐variance efficient choice rarely exceeds a small fraction of one percent per invested dollar.