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Time Diversification, Safety-First and Risk

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  • Milevsky, Moshe Arye

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. Copyright 1999 by Kluwer Academic Publishers

Suggested Citation

  • Milevsky, Moshe Arye, 1999. "Time Diversification, Safety-First and Risk," Review of Quantitative Finance and Accounting, Springer, vol. 12(3), pages 271-281, May.
    • Handle: RePEc:kap:rqfnac:v:12:y:1999:i:3:p:271-81
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    Cited by:

    1. K. Ko & Zhijian Huang, 2012. "Time-inconsistent risk preferences in a laboratory experiment," Review of Quantitative Finance and Accounting, Springer, vol. 39(4), pages 471-484, November.
    2. Theodoros M. Diasakos, 2011. "A Simple Characterization of Dynamic Completeness in Continuous Time," Carlo Alberto Notebooks 211, Collegio Carlo Alberto.
    3. Levy, Haim & Levy, Moshe, 2009. "The safety first expected utility model: Experimental evidence and economic implications," Journal of Banking & Finance, Elsevier, vol. 33(8), pages 1494-1506, August.
    4. Diasakos, Theodoros M, 2013. "Comparative Statics of Asset Prices: the effect of other assets' risk," SIRE Discussion Papers 2013-94, Scottish Institute for Research in Economics (SIRE).
    5. M. C. Chiu & D. Li, 2009. "Asset-Liability Management Under the Safety-First Principle," Journal of Optimization Theory and Applications, Springer, vol. 143(3), pages 455-478, December.
    6. Chiu, Mei Choi & Wong, Hoi Ying & Zhao, Jing, 2018. "Dynamic safety first expected utility model," European Journal of Operational Research, Elsevier, vol. 271(1), pages 141-154.
    7. Haim Levy, 2010. "The CAPM is Alive and Well: A Review and Synthesis," European Financial Management, European Financial Management Association, vol. 16(1), pages 43-71, January.

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