Time Diversification, Safety-First and Risk

Time Diversification, Safety-First and Risk The purpose of this article is to demonstrate the effect of investment time horizon on the choice of risky assets in a portfolio when the investor in question is optimizing a Safety-First (downside risk-aversion) utility function. It is shown, under standard assumptions, that although shortfall risk decreases exponentially with investment time horizon, the portfolio asset allocation proportions remain invariant. In fact, in some instances, the optimal allocation will not even depend on the drift of the underlying assets. Thus, we extend the classical results of Samuelson and Merton, derived under conventional utility assumptions, to an individual optimizing an A.D. Roy Safety-First objective; a discontinuous utility function that has been extolled as conforming to observed investor behaviour. A numerical example is provided. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

Time Diversification, Safety-First and Risk

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Publisher
Springer Journals
Copyright
Copyright © 1999 by 1999 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands.
Subject
Finance; Corporate Finance; Accounting/Auditing; Econometrics; Operation Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1023/A:1008326915984
Publisher site
See Article on Publisher Site

Abstract

The purpose of this article is to demonstrate the effect of investment time horizon on the choice of risky assets in a portfolio when the investor in question is optimizing a Safety-First (downside risk-aversion) utility function. It is shown, under standard assumptions, that although shortfall risk decreases exponentially with investment time horizon, the portfolio asset allocation proportions remain invariant. In fact, in some instances, the optimal allocation will not even depend on the drift of the underlying assets. Thus, we extend the classical results of Samuelson and Merton, derived under conventional utility assumptions, to an individual optimizing an A.D. Roy Safety-First objective; a discontinuous utility function that has been extolled as conforming to observed investor behaviour. A numerical example is provided.

Journal

Review of Quantitative Finance and AccountingSpringer Journals

Published: Oct 15, 2004

References

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