Differences Between Short‐ and Long‐Term Risk Aversion: An Optimal Asset Allocation Perspective

Abstract

This paper studies the long‐term asset allocation problem of an investor with different risk aversion attitudes to the short and the long term. We characterize investor's preferences with a utility function exhibiting a regime shift in risk aversion at some point of the multiperiod investment horizon that is estimated using threshold nonlinearity methods. Our empirical results for a portfolio of cash, bonds and stocks suggest that long‐term risk aversion is higher than short‐term risk aversion and increases with the investment horizon. The exposure of the investment portfolio from stocks to bonds and cash increases with the degree of risk aversion.

Risk-Averse Planning Under Uncertainty

“…We refer to a controlled Markov process with the "nested" objective ( 8) a risk-averse Markov process. Many applications such as portfolio allocation problems [10] and organ transplant decisions [14] require a risk-averse Markov model. It was also previously demonstrated in [9], [24] that coherent risk measure objectives can account for modeling errors and parametric uncertainty in MDPs.…”