Non-satiation and risk aversion

There are two assumptions implicit in the portfolio selection problem. First, investors want to select a portfolio, which provides the highest possible return. An assumption of non-satiation is made n the Markowitz portfolio, in which investors are assumed to always prefer higher levels of terminal wealth to lower levels of terminal wealth. Therefore, given two portfolios with the same standard deviations, the investor will choose the portfolio with the higher expected return.

The portfolio theory presumes that individual investors attempt to maximize the utility of their portfolios. However, since individuals differ in their attitude toward risk, differences in their risk aversion factor will lead to different investment policies. The portfolio theory defines three types of investors:

Risk averse: Investors who have positive risk aversion factors. They view the true return that is earned on an investment as being its expected return, less an amount that compensates for its risk.

Risk neural: Investors who have a risk aversion factor equal to zero. Their utility functions only consist of an investments expected return. Such investors tend to ignore risk when making an investment decision.

Risk loving: Investors who have negative risk aversion factors. This means that, for them, the greater the risk, the more they like an investment. They view the true compensation that an investment offers as consisting of both its expected return and the thrill of the game.