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Time diversification: Definitions and some closed-form solutions

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  • Chung, Kee H.
  • Smith, William T.
  • Wu, Tao L.
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    Abstract

    We establish general conditions under which younger investors should invest a larger proportion of their wealth in risky assets than older ones. In the finite horizon dynamic setting, we show that such phenomenon, known as ''time diversification," can occur in the presence of human wealth, guaranteed consumption, or mean-reverting stock returns. We formalize two alternative notions of time diversification commonly confounded in the literature. Analytic solutions are provided for both time-series and cross-sectional forms of time diversification. To our best knowledge, this paper is the first to solve in closed-form the hedging demand for a CARA investor with inter-temporal consumption and a finite horizon, facing mean-reverting expected returns. Our results indicate that horizon can have a significant effect on the portfolio demand of a CARA investor due to inter-temporal hedging.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 33 (2009)
    Issue (Month): 6 (June)
    Pages: 1101-1111

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    Handle: RePEc:eee:jbfina:v:33:y:2009:i:6:p:1101-1111

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    Web page: http://www.elsevier.com/locate/jbf

    Related research

    Keywords: Portfolio choice Asset allocation Time-series time diversification Cross-sectional time diversification;

    References

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    Cited by:
    1. Raúl Ibarra-Ramírez, 2011. "Stocks, Bonds and the Investment Horizon: A Spatial Dominance Approach," Working Papers 2011-03, Banco de México.
    2. Ibarra, Raul, 2013. "A spatial dominance approach to evaluate the performance of stocks and bonds: Does the investment horizon matter?," The Quarterly Review of Economics and Finance, Elsevier, vol. 53(4), pages 429-439.
    3. Bai, Ye & Green, Christopher J., 2010. "International diversification strategies: Revisited from the risk perspective," Journal of Banking & Finance, Elsevier, vol. 34(1), pages 236-245, January.

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