Portfolio choice with endogenous utility: a large deviations approach

This paper provides an alternative behavioral foundation for an investorʹs use of power utility in the objective function and its particular risk aversion parameter. The foundation is grounded in an investorʹs desire to minimize the objective probability that the growth rate of invested wealth will not exceed an investor-selected target growth rate. Large deviations theory is used to show that this is equivalent to using power utility, with an argument that depends on the investorʹs target, and a risk aversion parameter determined by maximization. As a result, an investorʹs risk aversion parameter is not independent of the investment opportunity set, contrary to the standard model assumption.