Misconceptions about Optimal Equity Allocation and Investment Horizon

Abstract

Our analysis and results offer some resolution to a debate that has continued for 30 years. We demonstrate that, in contrast to prior claims, no conflict exists between the implications of economic models of choice under uncertainty and a rational investor preference for larger equity allocations at longer investment horizons. Using examples of expected utility of wealth and mean–variance utility, we show that the effect of a longer horizon on risky-asset allocation is consistent with increasing or decreasing optimal equity allocations, even under the assumption of constant relative risk aversion.

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