Asset Allocation with Different Short- and Long-Term Risk Aversion

What is it about?

This article proposes a flexible approach for incorporating differences in the individuals’ risk aversion profile to the short term and the long term when considering investment decisions. This is done by allowing two different regimes in individuals’ risk aversion such that different economic and financial variables may drive short-term and long-term risk aversion. We assess empirically these differences in risk aversion for a tactical portfolio of stocks, bonds and cash, and find that the individuals’ risk aversion is different depending on the investment horizon. We also observe that the optimal allocation to bonds is more sensitive than the allocation to stocks to changes in the term structure of individuals’ risk aversion with respect to the investment horizon.

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Why is it important?

We assess empirically the differences in risk aversion for a tactical portfolio of stocks, bonds and cash, and find that the individuals’ risk aversion is different depending on the investment horizon. We also observe that the optimal allocation to bonds is more sensitive than the allocation to stocks to changes in the term structure of individuals’ risk aversion with respect to the investment horizon.

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