Implicit Assumption and its Consequences with Expected Utility Maximization

Abstract

In searching for the optimal preference-free solution for demand of risks, most existing models maximize risk-averse agents’ expected utility with an implicit constant-solution assumption a priori. For these problems with unique solution, this extra assumption demands a restrictive distribution for the existence of optimal solution. Consequences are examined for the portfolio separating distributions and cross hedging theory. Removing such assumption, a class of more general distributions allowing for preference-free solution is suggested. Such distribution invalidates the portfolio separation effects for the optimal portfolio problem and permits more flexible cross hedging models with explicit optimal solutions that greatly simplify existing theory.