Optimal Portfolios for the Long Run
Abstract:Then why the hell do longer-dated equity puts cost more than their short-dated brethren?
There is surprisingly little agreement among academics about the existence of time diversification, which we define as the anomaly where equities become less risky over longer investment periods. This study provides the most thorough analysis of time diversification conducted, using 113 years of historical data from 20 countries (over 2,000 years of total return data). We construct optimal portfolios for 20 different countries based on varying levels of investor risk aversion and time horizons using both overlapping and distinct historical time periods.
We find strong historical evidence to support the notion that a higher allocation to equities is optimal for investors with longer time horizons, and that the time diversification effect is relatively consistent across countries and that it persists for different levels of risk aversion. We also note that the time diversification effect increased throughout the 20th century despite evidence of a declining risk premium. Although time diversification has been criticized as inconsistent with market efficiency, our empirical results suggest that the superior performance of equities over longer time horizons exists across global equity markets and time periods.
HT: Abnormal Returns
Free download (27 page PDF)
It wasn't me asking the puts question, it was Boston University's pension/retirement maven Zvi Bodie at William Bernstein's Efficient Frontier: "Zvi Bodie and the Keynes’ Paradox of Thrift" back in 2003.
(now I know the arguments against Bodie's implication, here's a decent one, here's a counter to the counter, we've got links, baby.)
See also: "‘Buffett Puts’ Prospered in 2012"
The point is, there is some serious mispricing going on.
