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Dynamic Choice and Risk Aversion

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Author Info
Jun Liu (Anderson School of Management)
Abstract

This paper explicitly solves a dynamic portfolio choice problem in which an investor allocates his wealth between a riskless and a risky asset. The solution shows that insights gained from studying static portfolio choice problems do not necessarily carry over to dynamic choice settings. For example, even though the risk premium of the risky asset in the problem presented here is strictly positive, holdings of that risky asset might increase with risk aversion. More surprisingly, a risk-averse investor might take a short position in the risky asset. The findings suggest that using stock holdings as a proxy for risk aversion may be inappropriate. Finally, I show that volatility might not prevent a risk averse investor from holding an infinite amount of a risky asset, contrary to Harry Markowitz's insights on the static portfolio choice

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File URL: http://repositories.cdlib.org/cgi/viewcontent.cgi?article=1005&context=anderson/fin
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Publisher Info
Paper provided by Anderson Graduate School of Management, UCLA in its series University of California at Los Angeles, Anderson Graduate School of Management with number 1005.

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Date of creation: 01 Aug 2001
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Handle: RePEc:cdl:anderf:1005

Note: oai:cdlib1:anderson/fin-1005
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Related research
Keywords: dynamic choice; risk aversion; stochastic volatility;

References listed on IDEAS
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  1. Heaton, John & Lucas, Deborah, 1997. "Market Frictions, Savings Behavior, And Portfolio Choice," Macroeconomic Dynamics, Cambridge University Press, vol. 1(01), pages 76-101, January. [Downloadable!]
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This page was last updated on 2009-12-15.

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