Following on from the prior post taken from Kritzman's article on time diversification in the Financial Analysts Journal.
Here are a few reasons why you might still condition your risk posture on your investment horizon, even though you accept the mathematical truth about time diversification:
(1) You may not believe that risky asset returns are random. If returns revert to their mean, then the dispersion of terminal wealth increases at a slower rate than implied by a lognormal distribution. If you are more averse to risk than the degree of risk aversion implicit in a log wealth utility function, then a mean reverting process will lead you to favor risky assets over a long horizon, even if you are indifferent between a riskless and a risky asset over a short horizon.
(2) You might believe that the extremely bad outcomes required to justify the irrelevancy of time diversification would result from events or conditions that would have equally dire consequences for the so called riskless asset, especially if you measure wealth in consumption units.
(3) Even if you believe that returns are random, you might still choose to accept more risk over longer horizons than over shorter horizons because you have more discretion to adjust your consumption and work habits. The argument against time diversification assumes implicitly that your terminal wealth depends only on investment performance (poor assumption).
(4) You have a discontinuous utility function.
(5) You are irrational.
No comments:
Post a Comment