Asset class allocation and downside risk: does the investment horizon matter?
AbstractThe main objective of this paper is to analyze within the Mean-Downside Risk (MDR)-framework the relevance of the investment horizon for deriving optimal US asset class allocations. The choice of this risk framework is motivated by its close connection towards the way investors perceive risk and the fact that it is much more general than the often used Mean-Variance (MV) analysis. Unlike the MV-studies of Levy and Gunthorpe (1993) and Thorley (1995) we do not assume returns to follow a random walk. Instead we use a vector autoregressive specification to model the historical time series such that short-term first-order auto- and crosscovariances are preserved. Different from the MV-paper of Lee (1990) is that we explicitly model the short-term first-order auto- and crosscovariances and that we consider more than two asset classes. Our simulation tests show the weight assigned to stocks to be positively related to the length of the investment horizon. This contradicts the MV-findings of Lee (1990), Levy and Gunthorpe (1993) and Thorley (1995). The relation appears to be most apparent for investors with a low downside-risk aversion. However, even investors whose downside-risk, aversion parameter goes to infinity end up with 11% in stocks for long horizons. This conclusion is based on various assumptions. In order to get insight in the robustness of our results we carried out an extensive sensitivity analysis with respect to the inputs. Only in the situation where we assume a form of investor behavior that is beyond the one that is
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics in its series Serie Research Memoranda with number 0012.
Date of creation: 1997
Date of revision:
Contact details of provider:
Web page: http://www.feweb.vu.nl
Find related papers by JEL classification:
- D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving
This paper has been announced in the following NEP Reports:
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- R. Mehra & E. Prescott, 2010.
"The equity premium: a puzzle,"
Levine's Working Paper Archive
1401, David K. Levine.
- Andrew W. Lo & A. Craig MacKinlay, 1989.
"Stock Market Prices Do Not Follow Random Walks: Evidence From a Simple Specification Test,"
NBER Working Papers
2168, National Bureau of Economic Research, Inc.
- Andrew W. Lo, A. Craig MacKinlay, 1988. "Stock Market Prices do not Follow Random Walks: Evidence from a Simple Specification Test," Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 41-66.
- Fishburn, Peter C, 1977. "Mean-Risk Analysis with Risk Associated with Below-Target Returns," American Economic Review, American Economic Association, vol. 67(2), pages 116-26, March.
- Keim, Donald B. & Stambaugh, Robert F., 1986.
"Predicting returns in the stock and bond markets,"
Journal of Financial Economics,
Elsevier, vol. 17(2), pages 357-390, December.
- Donald B. Keim & Robert F. Stambaugh, . "Predicting Returns in the Stock and Bond Markets," Rodney L. White Center for Financial Research Working Papers 15-85, Wharton School Rodney L. White Center for Financial Research.
- Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 246-73, April.
- Mao, James C T, 1970. "Survey of Capital Budgeting: Theory and Practice," Journal of Finance, American Finance Association, vol. 25(2), pages 349-60, May.
- Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
- Campbell, John, 1987.
"Stock Returns and the Term Structure,"
3207699, Harvard University Department of Economics.
- Friend, Irwin & Blume, Marshall E, 1975. "The Demand for Risky Assets," American Economic Review, American Economic Association, vol. 65(5), pages 900-922, December.
- Kroll, Yoram & Levy, Haim & Markowitz, Harry M, 1984. " Mean-Variance versus Direct Utility Maximization," Journal of Finance, American Finance Association, vol. 39(1), pages 47-61, March.
- Levy, H & Markowtiz, H M, 1979. "Approximating Expected Utility by a Function of Mean and Variance," American Economic Review, American Economic Association, vol. 69(3), pages 308-17, June.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (R. Dam).
If references are entirely missing, you can add them using this form.