On The Shape of Risk Aversion and Asset Allocation

29 Pages Posted: 29 Mar 2011 Last revised: 12 Sep 2011

Date Written: September 12, 2011

Abstract

This paper focuses on asset allocation. We show how any shapes of risk aversion can be modeled to incorporate the mixed evidence suggested by the empirical studies about this important subjective variable (e.g., Holt and Laury, 2002; Meyer and Meyer, 2005; Guiso and Paiella, 2008). Our setting builds on and can be compared to the well-known Constant Relative Risk Aversion (CRRA) framework. Our empirical results exhibit a mean-reverting pattern of optimal assets demands even for the case of the constant opportunity set (Merton, 1969). This feature stands against the mean-reverting pattern of assets demands usually linked to the mean-reversion behavior of stock prices (Poterba and Summers, 1988; Wachter, 2002). We demonstrate that this mean-reverting pattern is amplified by the volatility of the market and diminished by investment horizon.

Keywords: Risk Aversion, Asset Allocation, Mean-Reversion, Wealth, Options

JEL Classification: G11

Suggested Citation

Six, Pierre, On The Shape of Risk Aversion and Asset Allocation (September 12, 2011). Available at SSRN: https://ssrn.com/abstract=1797762 or http://dx.doi.org/10.2139/ssrn.1797762

Pierre Six (Contact Author)

Neoma Business School ( email )

1, rue du Maréchal Juin - BP 188
Mont Saint Aignan Cedex, Normandy 76825
France

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