Expected utility approximation and portfolio optimisation

Classical portfolio selection problems that optimise expected utility can usually not be solved in closed form. It is natural to approximate the utility function, and we investigate the accuracy of this approximation when using Taylor polynomials. In the important case of a Merton market and power utility we show analytically that increasing the order of the polynomial does not necessarily improve the approximation of the expected utility. The proofs use methods from the theory of parabolic second-order partial differential equations. All results are illustrated by numerical examples.