From Value Walk:
New Evidence That Time Diversification Exists, Violates Black-Scholes
Time diversification, the idea that risk drops the longer you hold a stock, is controversial. Finance theory says that it doesn’t exist, but there is some empirical evidence that it does. Proponents of time diversification have mostly focused on U.S. markets over the last century to prove their case, but a new study has taken a much broader view, 20 countries over 113 years, and has found statistically significant evidence that time diversification is a real effect that analysts should take into account when making recommendations.
Time diversification contradicts accepted theory
The research team, composed of Morningstar director of retirement research David Blanchett, Texas Tech University Professor Michael Finke, and American College Professor Wade Pfau, is well aware that time diversification contradicts accepted theory. “The primary critique of time diversification is theoretical and the primary defense empirical,” they write. “Time diversification violates the Black-Scholes option pricing model.”To test theory they looked at how different portfolios would have performed over time spans ranging from one to twenty years, both for individual countries and in the aggregate. They also included varying levels of risk aversion to account for variations in performance. The result was that even the most risk averse investors should allocate a very high percentage of their portfolio to equities: more than 70 percent.
Level of diversification
But the level of time diversification, while statistically present in all 20 countries the team reviewed, varied dramatically. Taking the two extremes, in Australia it was almost always correct to put 80 percent or more of your portfolio in equities, while investors in Switzerland with moderate risk aversion should have less than 30 percent of their holdings as equities....MORE
