Probability

Utility

A function mapping wealth to satisfaction, used to explain why people do not maximise expected value.

Concave utility means diminishing marginal value of wealth, which is risk aversion. It resolves the St Petersburg paradox, where a bet with infinite expected value is obviously not worth infinite money.

Log utility is the case that matters most in trading: it implies Kelly betting, penalises ruin infinitely (log of zero is negative infinity), and produces the growth-optimal strategy.

The practical reading. Maximising expected wealth and maximising expected log wealth give very different position sizes, and the second is the one that survives repeated play.

Related terms

Practise this

Put it into practice

Knowing the definition is not the same as spotting where it applies under time pressure. Work the question bank free.

Start practising free

Browse the full quant interview glossary