Long-Term Portfolio Choice

Bernd Scherer

One of the basic questions in long-run portfolio choice is “should investors with long time horizons hold a larger fraction of stocks in their portfolio?”. Academically, there is a sophisticated theoretical and empirical literature developing around this very question that takes predictability, learning, human capital and parameter uncertainty into account with very different results on how the time horizon might affect asset allocation.11See Brandt et al (2005) for a review. Unlike academia, the asset management industry have already made their mind up with an unconditional “yes”: investors with longer time horizons should hold more equity. This chapter reviews the basic techniques and literature employed in long-term portfolio choice.

18.1 LONG-TERM PORTFOLIO CHOICE UNDER INDEPENDENT AND IDENTICALLY DISTRIBUTED RETURN ASSUMPTIONS: TWO FALLACIES

We start with in a world with independent and identically distributed (iid) returns (there is no exploitable pattern in returns). In other words, investment opportunities are constant. With no time variation in investment opportunities, investors have no reason to hedge against changes in future investment opportunities. This is sometime

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