Expected utility theory (EUT) is the foundation for decision-making under risk and uncertainty. Although EUT is elegant, a more practical framework that is logically consistent with EUT would be quite useful, and this is where the mean-variance and stochastic dominance models come into play. Essentially, the mean-variance and stochastic dominance models represent “special cases” of EUT, and as such, these models provide useful shortcuts to EUT.
Tomorrow, we will complete our coverage of the “Decision Making under Risk and Uncertainty” topic by focusing further attention on the so-called mean-variance model and introducing the stochastic dominance model.
Thursday’s class will be devoted to a review session for Midterm Exam #1, which is scheduled to occur in class on Tuesday, February 18. I highly recommend that students read the 2-page Finance 4335 Midterm 1 Synopsis prior to coming to class that day. I also recommend reviewing the various class problems and problem sets that have been assigned and midterm 1 from Fall 2019. After Thursday’s class next Thursday, I will post the solutions for problem set 4 and for Fall 2019 midterm 1 so that everyone will the opportunity to check their work on these assignments.